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UNIVERSITY 

OF  CALIFORNIA 

LOS  ANGELES 


SCHOOL  OF  LAW 
LIBRARY 


Digitized  by  the  Internet  Archive 

in  2007  with  funding  from 

Microsoft  Corporation 


http://www.archive.org/details/bankingprinciple01westiala 


BANKING    PRINCIPLES 
AND   PRACTICE 


By 
RAY  B.WESTERFIELD,  Ph.D. 

Assistant  Professor  of  Political  Economy,  Yale  University; 
Secretary-Treasurer,  American  Economic  Association 


IN  FIVE  VOLUMES 

VOLUME  I 

ELEMENTS  OF  MONEY,  CREDIT,  AND 
BANKING 


i 

NEW  YORK 

THE  RONALD  PRESS  COMPANY 

1  1921 


Copyright,  192 1,  by 
The  Ronald  Press  Company 


All  Rights  Reserved 


*ft 


V3 

■4 


TO 

My  Mother  and  Father 


PREFACE 

The  aim  of  this  book  is  to  give  a  comprehensive  exposition 
of  the  theory  and  practice  of  commercial  banking  in  the  United 
States.  In  its  preparation  the  author  has  been  guided  by  the 
following  principles: 

i.  To  move  from  general  to  particulars,  that  is,  from  general 
theory  in  the  first  volume  and  a  comprehensive  description  of  the 
banking  system  of  the  United  States  in  the  second  volume  to  a 
detailed  statement  of  the  internal  organization  and  of  the  oper- 
ations of  a  member  bank  in  the  last  three  volumes. 

2.  To  present  so  much  of  the  historical  and  genetical  back- 
ground of  institutions  and  practices  as  will  give  them  a  true  set- 
ting and  explain  their  fundamental  nature. 

3.  To  approach  each  problem  from  the  American  point  of 
view  and  describe  the  American  system,  statements  of  foreign 
practice  being  given  only  where  comparisons  adverse  to  the 
American  may,  it  is  hoped,  lead  to  reform,  or  where  clarity  of 
exposition  may  be  gained  or  theories  illustrated. 

4.  To  feature  the  legal  phases  of  American  banking,  char- 
acterized as  it  is  by  legal  restraints,  regulations,  and  promotions. 

5.  To  emphasize  the  national  banks,  because  while  they  are 
fewer  in  number  than  the  state  banks,  they  have  larger  resources 
and  uniform  charters,  operate  under  the  same  law  and  supervision , 
and  all  belong  to  the  federal  reserve  system,  a  centralizing  scheme 
which,  it  is  hoped,  will  in  time  envelop  and  control  all  banks. 

6.  To  approach  the  problems  from  the  point  of  view  of  a  very 
large  bank,  in  the  metropolis  of  the  country,  in  Wall  Street,  the 
financial  center  of  the  western  world  and  nearly  as  important  as 
Lombard  Street,  London. 

7.  To  describe  banking  practice  in  as  general  terms  as  possible 
as  a  functional  thing  to  be  carried  out  in  any  bank  however  much 

v 


VI  PREFACE 

differences  of  internal  organization  may  vary  the  details  of 
execution. 

8.  To  present  an  intimate  correlation  of  banking  theory 
and  banking  practice,  giving  in  the  first  volume  the  underlying 
theory  of  money,  credit,  and  banking  as  a  prerequisite  to  an 
effective  presentation  in  the  remaining  volumes  of  the  organi- 
zation and  practice  of  the  system  as  a  whole  and  of  the  individual 
member  banks  of  that  system,  and  indicating  at  every  op- 
portunity in  the  treatment  of  the  internal  and  external  operations 
of  a  bank  the  theory  underlying  the  practice. 

The  operations  of  a  modern  bank  cover  both  domestic  and 
foreign  business.  In  this  book,  those  pertaining  to  domestic 
transactions  and  handled  for  domestic  clients,  which  of  course 
constitute  by  far  the  larger  proportion,  are  treated  in  Volumes  III 
and  IV.  While  all  the  domestic  operations  of  a  bank  are  so  inter- 
related that  a  clear  line  of  cleavage  is  difficult  to  draw,  the  de- 
scription of  the  internal  organization  of  a  bank,  of  the  operations 
concerned  with  cash,  deposits,  and  letters  of  credit,  and  of  the 
work  of  the  bookkeepers  and  auditors,  is  treated  in  Volume  III 
under  the  rather  general  title  of  "  Cash  and  Deposit  Operations." 
The  operations  pertaining  to  discounts,  loans,  credits,  commercial 
paper,  and  investments  are  treated  in  Volume  IV,  under  the 
general  title  of  "Earning  Assets." 

The  operations  pertaining  to  foreign  business  are  treated  in 
Volume  V. 

It  is  a  pleasure  for  the  author  to  acknowledge  his  great  debt  to 
the  many  persons  who  have  helped  in  the  preparation  of  these 
volumes.  He  is  particularly  indebted  to  the  staff  of  the  National 
City  Bank  of  New  York  where  during  his  employment  the  book 
was  started.  Although  this  employment  gave  instance  to  the 
book,  it  has  wholly  outgrown  the  original  plan  and  in  its  com- 
pleted form  does  not  in  any  way  purport  to  describe  the  actual 
operations  of  that  or  any  other  specific  bank,  but  rather  of  a 
generalized  bank. 


PREFACE  vii 

To  ascertain  data  on  specific  points  it  has  been  necessary  to 
write  hundreds  of  letters  to  various  federal  and  state  officials  and 
to  banks  and  banking  institutions  throughout  the  country,  and 
acknowledgment  is  here  made  of  the  courteous  replies  thereto. 
Many  others  have  shown  equal  courtesy  in  personal  interviews. 
Mr.  Carl  Llewellyn  kindly  read  and  criticized  certain  chapters 
having  a  legal  nature.  Finally  the  author  is  deeply  grateful  to 
Miss  Clara  B.  Underwood  for  her  painstaking  work  in  the  prepa- 
ration of  the  copy  and  proof. 

Ray  B.  Westerfield. 
New  Haven,  Conn. 
December  6,  1921. 


CONTENTS 


VOLUME  I— ELEMENTS  OF  MONEY,  CREDIT,  AND  BANKING 

Chapter  Page 

I    Metallic  Money 3 

Relation  of  Money  and  Banking  Principles 

The  First  Exchanges 

Primary  Functions  of  Money 

Minor  Functions  of  Money 

Characteristics  of  Commodities  Used  as  Money 

Metals  as  Money 

Coinage 

Legal  Tender 

Brassage  and  Seigniorage 

Bimetallism  versus  Monometallism 

Operation  of  Bimetallism  Illustrated 

Effect  of  Two  Legal  Tenders 

The  Limping  Standard 

Relation  of  Seigniorage  to  Value  of  Coins 

Means  of  Maintaining  Public  Confidence 

II    History  of  the  National  Coinage 18 

First  Coinage  Act 

Changes  in  the  Mint  Ratio 

Coinage  of  the  Silver  Dollar 

Gold  Standard  Act 

The  Pittman  Act 

Other  Coinage  Laws 

Bullion  Bars 

Foreign  Shipments  of  Gold 

Gold  Coins  in  Circulation 

Silver  Coins  in  Circulation 

Other  Issues  of  Silver  Coin 

Nickel  and  Copper  Coins 

Statistical  Statement  of  the  Coinage 

Legal  Tender  of  Coins 

United  States  Mints  and  Assay  Offices 

Other  Functions  of  the  Mints 

III    Credit 35 

Confidence  and  Time  Element 
The  Contract  Element 
Credit  a  Substitute  for  Money 
The  Personal  Element  in  Credit 


X  CONTENTS 

Chapter  PAGE 

Secured  Credit 

Credit  Indorsement  and  Substitution 

Commercial  and  Financial  Credits 

Definition  of  Commercial  Credit 

Effect  of  Time  Element  on  Credit  Values 

Other  Kinds  of  Credit 

Relation  of  Credits  to  Wealth 

Fundamental  Basis  of  Credit 

Relation  of  Credits  to  Interest 

Credits  as  Circulating  Media 

IV    Government  Paper  or  Credit  Money 48 

Wide  Acceptability  of  Government  Credit 

Classification  of  Government  Credit  Money 

Value  of  Inconvertible  Money 

Danger  of  Overissue  of  Government  Paper  Money 

Advantages  and  Disadvantages  of  Paper  Money 

Government  Paper  Money  Issued  by  the  United  States 

Greenbacks 

Treasury  Notes  of  1 890 

Gold  and  Silver  Certificates 

Gold  Order  Certificates 

Federal  Reserve  Notes 

Method  of  Issuance 

Method  of  Redemption 

Money  Circulating  in  the  United  States 

V    Nature  of  Bank  Credit 66 

Specialization  in  Credit  Issue 

Forms  of  Bank  Credit 

Nature  of  Cash  Deposits 

Motives  in  Depositing  Cash  Funds 

Nature  of  Loans 

Nature  of  Discounts 

Effect  of  Loans  and  Discounts  on  Deposits 

Rationale  of  Exchange  of  Credits 

Limitation  on  Creation  of  Deposits  of  Bank  in  System 

Illustration  of  Need  of  Common  Ratio 

Ratio  of  Loans  to  Deposits 

Bank  Notes 

Summary — The  Three  Functions  of  Commercial  Banking 

Capital 

Surplus  and  Undivided  Profits 

VI    Bank  Operations  and  Functions 87 

Fundamental  and  Other  Functions 
Banks  as  Credit  Markets 
Extensions  of  Investment  Credit 
Loan  Ratios  as  Business  Barometers 


CONTENTS  Xl 


Chapter  Page 

Effect  of  Other  Operations  on  the  Bank  Statement 

Typical  Bank  Statement 

Clearings  and  Collections 

Methods  of  Presentment 

The  Clearing  House 

Out-of-Town  Collections 

VII    Protection  of  Bank  Note  Holders        105 

Nature  of  Bank  Notes 
Bank  Notes  and  Deposits — Similarity 
Bank  Notes  and  Deposits — Differences 
Reasons  for  Special  Protection  of  Noteholders 
Currency  Principle  versus  Banking  Principle 
Safeguards  against  Bank  Insolvency 
Objects  of  Protecting  Bank  Notes 

1.  Maintaining  Parity 

2.  Providing  Payment  at  Par 

3.  Elasticity  of  Note  Issues 
Methods  of  Attaining  Elasticity 
Existing  Systems  of  Protecting  Bank  Notes 
Bank  Notes  in  France 

Bank  Notes  in  England 
Bank  Notes  in  Germany 
Bank  Notes  of  Canada 
Bank  Notes  in  the  United  States 

VIII    Protection  of  Depositors 129 

Special  Protection  in  the  United  States 

Provision  for  Protection 

Methods  of  Guaranteeing  Deposits 

Safety  Fund  Plan 

The  Oklahoma  System 

Unfavorable  Conditions  in  Oklahoma 

Popularity  of  the  System 

The  Kansas  System 

Strength  of  Kansas  System 

Arguments  for  Guaranty  of  Deposits 

Effect  of  Guaranty  on  Panics 

Guaranty  of  Savings  Deposits  and  Commercial  Deposits 

Effect  of  Guaranty  on  Banks 

Guaranty  as  Assessment  Insurance 

IX    Reserves  for  Protection  of  Bank  Credit       ....     145 

Considerations  Governing  Size  of  Cash  Reserve 
Desirability  of  Minimum  Reserve 
Methods  of  Increasing  Reserves 
Importance  of  Regulating  Cash  Reserve 
Essentials  of  Secondary  Reserve 
Convertible  Forms  of  Earning  Assets 


Xli  CONTENTS 


Chapter  Page 

Liquidity  for  Banking  System  as  a  Whole 
Effect  of  War  on  Liquidity  of  Assets 
Protection  of  Acceptances  and  Letters  of  Credit 
Limitation  of  Acceptance  Credit 
Difference  between  Accepting  and  Lending 
Protection  of  Bills  Payable 

X    Relation  of  Bank  Credit  to  Prices 161 

Marginal  Utility  and  Price 

Basis  of  Price  Level 

Effect  of  Money  and  Deposits  on  Price  Level 

Remoter  Influences  on  Prices 

Index  Numbers 

Inflation  and  Its  Effects 

Inequalities  of  Inflation 

Interest  Rate  and  Inflation 

Schemes  of  Price  Adjustment 

Financial  Panics  and  Industrial  Crises 

Overproduction  and  Underproduction 

Effect  of  Investment  on  Production 

Psychological  Factors 

Periodicity  of  Panics 

XI    Classification  and  Functions  of  Banks 180 

Specialization  of  Bank  Functions 

Classification  by  Functions 

Functions  of  Commercial  Banks 

Specialization  of  Commercial  Banks 

Savings  Banks 

Functions  of  Savings  Banks 

Functions  of  the  Bond  House  and  Investment  Bank 

Banking  and  Other  Operations  of  Bond  Houses 

General  Functions  of  Trust  Companies 

Advantages  of  Corporate  over  Individual  Trustee 

Trust  Functions  for  Individuals 

Trust  Functions  for  Corporations 

Insurance  and  Safe-Deposit  Functions 


VOLUME  H— THE  BANKING  SYSTEM  OF  THE  UNITED  STATES 

XII    Antecedents  of  the  Federal  Reserve  System        .     .     211 

Classification  of  the  Financial  Institutions 

The  First  Bank  of  the  United  States 

Services  of  First  Bank  to  Government 

Dissolution  of  First  Bank 

The  Second  Bank  of  the  United  States 

History  of  Second  Bank 

Weaknesses  in  Operation  of  Second  Bank 


CONTENTS  Xlll 


Chapter  Page 

Defects  of  Note  Redemption  System 

Services  of  Second  Bank  to  Commerce 

Causes  of  Dissolution  of  Second  Bank 

State  Banks  Before  the  Civil  War 

Causes  of  Panic  of  1837 

The  Independent  Treasury  System 

Bases  of  Note  Issue  Before  the  Civil  War 

Evils  of  Early  Bank  Note  Issues 

Proposed  Advantages  of  National  Bank  Note  Issue 

The  National  Banking  Act 

The  Growth  of  the  National  Banking  System 

Movement  to  Reform  National  Banking  System 

XIII    Federal  Reserve  Districts  and  Membership    .     .     .     238 

The  Federal  Reserve  Districts 
Boundaries  of  Federal  Reserve  Districts 
Domestic  Branches  of  Federal  Reserve  Banks 
Foreign  Branches  of  Federal  Reserve  Banks 
Membership  in  Federal  Reserve  System 
Legal  Requirements  of  Membership 
Procedure  in  Applying  for  Membership 
Growth  in  State  Bank  Membership 
Objections  to  Membership 
Reasons  for  Membership 
New  Powers  of  National  Banks 


XIV  Federal  Reserve  Banks 258 

Capitalization  of  Federal  Reserve  Banks 

Surplus 

Earnings  and  Operating  Costs 

The  Board  of  Directors 

Election  of  Directors 

The  Federal  Reserve  Agent 

Internal  Organization 

Reorganization  of  Federal  Reserve  Bank  of  New  York  1919 

The  Governor 

Powers  of  the  Reserve  Banks 

Typical  Bank  Departments 

Resources  and  Liabilities  of  the  Federal  Reserve  Banks 

Liabilities  of  the  Federal  Reserve  Banks 

Fiscal  Agents  of  the  United  States 

The  Treasury  and  Reserve  Banks 

Duties  of  Former  Sub-Treasuries 

XV    The  Federal  Reserve  Board 285 

Membership  of  the  Board 
Criticism  of  Constitution  of  the  Board 
Powers  and  Responsibilities 
Administrative  Duties 


XIV 


CONTENTS 


Chapter 


Page 


The  Federal  Advisory  Council 

The  Comptroller  of  the  Currency — Powers  and  Duties 

The  Comptroller's  Examiners 

National  Bank  Reports 


XVI    Domestic  and  Foreign  Branch  Banking 296 

Branch  Banking  Within  the  United  States 

State  and  National  Branch  Banks 

Development  of  Branch  Banking 

Need  for  Foreign  Branches  of  American  Banks 

Foreign  Branch  Banks  Established 

Ownership  and  Management  of  Foreign  Branches 

Growth  and  Functions  of  Foreign  Branches 

Federal  Foreign  Banking  Associations 

Provisions  of  the  Edge  Act 

Powers  of  the  Edge  Corporations 

Edge  Corporations  Established 


XVII    Legislation  Governing  National  Bank  Note  Issue    . 

Bond  Deposit  Requirement  from  1864  to  1900 

The  Aldrich-Vreeland  Act — Emergency  Circulation  of  As- 
sociations 

Emergency  Circulation  of  National  Banks 

Character  of  the  Emergency  Notes 

Effect  of  War  on  Emergency  Circulation 

Conversion  and  Refunding  of  Bonds  under  the  Federal 
Reserve  Act 

Effect  of  Liberty  Bond  Issues  on  Bond  Refunding  and 
Conversion 

Retirement  of  National  Bank  Notes 

The  Pittman  Act  of  191 8 

The  Deposited  Bonds 


3ii 


XVIII    National  Bank  Notes 328 

Preparation  of  National  Bank  Notes 

Denominations  and  Character 

The  Redemption  Fund 

Method  of  Note  Redemption 

Withdrawal  of  Circulation 

Effect  of  Liquidation 

Effect  of  Failure  to  Redeem  upon  Demand 

The  Tax  on  National  Bank  Notes 

Public  Advantages  of  National  Bank  Notes 

Banking  Advantages  of  National  Bank  Notes 

Method  of  Calculating  Profit  on  Note  Circulation 

Disadvantages  of  National  Bank  Notes 

Inelasticity 

Other  Disadvantages 


CONTENTS  xv 

Chapter  Page 

XIX    Federal  Reserve  Notes 350 

Issue  of  Federal  Reserve  Notes 

Methods  of  Redemption  and  Retirement 

Effect  of  Gold  Reserve  Concentration 

Amendment  Providing  for  Direct  Issue 

Reserves  of  Federal  Reserve  Banks 

Tax  on  Deficiency  of  Reserves 

Other  Devices  for  Obviating  Deficiencies  of  Reserves 

Movement  of  Reserve  Ratio 

Characteristics  of  Federal  Reserve  Notes 

Provisions  for  Controlling  Excessive  Issues 

Responsibility  for  Stemming  Inflation 

Safety  of  Federal  Reserve  Notes 

Elasticity  of  Federal  Reserve  Notes 

XX    Discount  Operations  of  the  Federal  Reserve  Banks     374 

Paper  Eligible  for  Rediscount 

1.  Rediscounting  for  Member  Banks 

Effect  of  War  on  Discount  of  Commercial  Paper 
Statistical  Statement  of  the  Discounts 

2.  Open-Market  Operations 

3.  Rediscount  Operations  Between  Federal  Reserve  Banks 
Discount  Rates  of  Federal  Reserve  Banks 

Factors  Influencing  Discount  Policy  of  Federal  Reserve  Board 
Control  by  Lines  of  Credit 

XXI    Reserves  Against  Deposits  Under  National  Banking 

Act 387 

Legal  Requirements 

System  of  Redeposited  Reserves 

Bank  Correspondents 

Effect  of  System  on  Concentration  of  Money 

Competition  for  Deposit  Balances 

Effect  of  Redeposited  Reserves  on  Securities  and  Money 

Markets 
Effect  on  Cash  Carried,  Exchange,  and  Accommodation 
Reserves  and  Stock  Exchange  Loans 
Fictitious  Reserves 
Evils  of  Legal  Minimum  Reserve 
Decentrab"zation  of  Reserves 

XXII    Reserves  Against  Deposits  Under  the  Federal  Re- 
serve Act 400 

Legal  Requirements 
Amendments  to  Reserve  Requirements 
Amounts  and  Distribution  of  Reserves 
Effects  of  Federal  Reserve  System  on  Reserves 
1 .  Reduction  of  Reserves 


XVI  CONTENTS 


Chapter  Page 

2.  Concentration  of  Reserves 

3.  Decentralization  of  Bank  Balances  in  Central  Reserve 
Cities 

4.  Cessation  of  Interest  Payments  on  Reserves 
Calculation  of  Reserves  of  Member  Banks  Against  Deposits 
Definition  of  Reserve  Cities 

Reserves  of  the  Federal  Reserve  Banks  Against  Deposits 

Nature  of  the  Gold  Settlement  Fund 

Operation  of  Gold  Settlement  Fund 

Functions  and  Transactions  of  Gold  Settlement  Fund 

Telegraphic  Transfer  of  Funds 

Members'  Drafts  on  Federal  Reserve  Banks 

The  Par  Collection  System 

Progress  of  Par  Collection  System 

Statistical  Statement  of  Deposits  in  the  United  States 

XXIII    Institutions    Other    Than    National   and    Federal 

Reserve  Banks        426 

Composition  of  the  Banking  System  of  the  United  States 
State  Banks — Growth 
Requirements  as  to  Capital 
Limitations  as  to  Loans 

Requirements  as  to  Reserves,  Branches,  and  Supervision 
Trust  Companies — Legal  Requirements 
Growth  of  Trust  Companies 
Causes  of  Recent  Growth 
Supervision  and  Regulation 
Private  Bankers 

Mutual  and  Joint-Stock  Savings  Banks 
Statistical  Statement  of  the  Banking  System  of  the  United 
States 

XXIV    Institutions    Other    than    National   and    Federal 

Reserve  Banks  (Continued)         443 

Postal  Savings  Banks 

School  Savings  Banks 

Building  and  Loan  Associations — Nature  and  Organization 

Operations  and  Functions 

Statistical  Summary 

Savings  in  the  United  States 

The  Loan  Shark 

Remedial  Loan  Systems  * 

Morris  Plan  Banks 

Advantages  of  Morris  Loan  Plan 

Cattle  Loan  Companies 

Nature  and  Terms  of  Cattle  Loans 

Rediscounting  Cattle  Paper 

Security  and  Liquidity  of  Cattle  Paper 

The  Federal  Farm  Loan  System 

Federal  Land  Banks 

Federal  Farm  Loan  Bonds 


CONTENTS  xvii 


Chapter  Page 

National  Farm  Loan  Associations 
Joint-Stock  Land  Banks 
Federal  Farm  Loan  Board 

XXV    Bank  Organization  and  Conversion 469 

Introductory- 
Organization  of  a  New  National  Bank 
Requirements  for  Formal  Application 
Examination  of  Application 

Articles  of  Association  and  Organization  Certificate 
Election  of  Directors  and  Officers 
Requirements  as  to  Capital  Stock  Subscriptions 
Requirements  as  to  Circulation 
Reorganization  of  a  Bank  into  a  National  Bank 
Conversion  of  a  State  Bank  into  a  National  Bank 
Organization  of  a  State  Bank — Preliminary  Requirements 
Authorization  Certificate 
Qualifications  of  Directors 
Organization  of  a  Trust  Company 
Conversion  of  a  State  Bank  into  a  Trust  Company 
Conversion  of  a  Trust  Company 
Organization  of  a  Mutual  Savings  Bank 

XXVI     Charter  Changes,  Consolidation,  and  Liquidation     .     486 

Increasing  Capitalization  of  a  National  Bank 

Reducing  Capitalization  of  a  National  Bank 

Extension  of  Charter 

Change  of  Name  or  Location 

Requirements  in  Amending  Charter 

Reasons  for  Consolidation  of  Banks 

The  Agreement  of  Consolidation 

Approval  of  Consolidation 

Methods  of  Consolidation 

Liquidation  of  National  Banks 

Conversion  of  a  National  Bank  into  a  State  Bank 


VOLUME     DJ— DOMESTIC     BANKING— CASH     AND     DEPOSIT 
OPERATIONS 

XXVII    Bank  Administration — Shareholders  and  Directors    511 

The  Management  of  a  Bank 

The  Shareholders  of  National  Banks 

Shareholders'  Meetings 

Shareholders'  Rights  and  Liabilities 

Election  of  Board  of  Directors 

Legal  Qualifications  of  Directors — Clayton  Act 

Amendments  to  Clayton  Act 

Selection  and  Services  of  Directors 

Functions  and  Powers  of  Boards  of  Directors 

Limitations  and  Responsibilities  of  Directors 


XVlll  CONTENTS 

Chapter  Page 

XXVIII    Bank  Administration — The  Officers       .     .  525 

The  President — Powers  and  Responsibilities 

The  Vice-President 

The  Cashier 

The  Powers  of  Cashier 

The  Departmentalization  of  a  Bank 

Methods  of  Growth  and  Expansion 

Types  and  Systems  of  Management 

Committee  System 

An  Illustrative  Organization 

The  Managerial  Functions 

The  Executory  Functions 

XXIX    The  Paying  Teller 542 

General  Duties  and  Qualifications 

Internal  Organization  of  Paying  Teller's  Department 

Handling  the  Bank's  Cash — The  Money  Department 

Payments  and  Receipts  by  Mail  and  Express 

Payments  at  the  Clearing  House — Pay-Rolls 

The  Paying  Teller's  Proof 

The  Payment  of  Checks 

' '  Stop-Payment ' '  Orders 

Raised,  Postdated,  and  Stale  Checks 

Identification  of  Presenter 

The  Signature  Department — Duties  and  Organization 

Identification  of  Signatures 

Routine  of  Work 

Procurement  of  Signatory  Authority 

Signatory  Authority  of  Corporations  and  Partnerships 

Account  of  Deceased  Depositors 

Trustee's,  Joint,  and  Other  Accounts 

Certification  Department — Function  and  Organization 

Outstanding  Certified  Checks  and  Identification  Receipt 

System 
Precautions  in  Certifying  Checks 
Day  Loans  and  Overcertification 
Certified  Checks  and  Bookkeeper's  Department 

XXX    The  Receiving  Teller 567 

General  Duties  and  Organization  of  Receiving  Teller's 

Department 
Opening  an  Account  and  Making  a  Deposit 
Nature  of  Deposits  and  Deposited  Items 
Handling  Deposited  Items 
The  Second  Teller's  Proof 

XXXI    The  Mail  Teller 576 

General  Duties  and  Organization  of  Mail  Teller's  Depart- 
ment 
Sorting  the  Morning  Mail 


CONTENTS 


xix 


Chapter 

Proving  the  Cash  Letters 

The  Assembly  Rack  Proof 

The  Charging  and  Distribution  of  Items 

Handling  the  Afternoon  Mail 

XXXII    The  Check  Desk  Department 


Page 


589 


General  Functions  and  Organization  of  the  Check  Desk 

Department 
Sorting  the  Items 
Examining  the  Items 
The  Proofs 
The  Ledgers 

Routine  of  Bookkeepers  in  Check  Desk  Department 
Posting  the  Exchanges 

Method  of  Handling  Overdrafts  and  "Holds" 
The  Balancing  of  the  Accounts 
Other  Duties  of  the  Check  Desk  Department 


XXXIII    The  Note  Teller  and  City  Collections 

Classification  of  Items  for  Collection  Purposes 

General  Functions  of  the  Note  Teller 

Handling  of  Notes  for  Collection 

Miscellaneous  Collections 

Miscellaneous  Duties 

Bookkeeping  and  Proofs 

Functions  of  the  City  Collection  Department 

Special  Collections 

Sight  Draft  Collections 

Returns 

Clearing  House  Returns — Special  Deposits 

Cash  Item  Proof 

Duties  of  the  Coupon  Collection  Department 

Sorting  and  Recording  the  Coupons 

Collection  of  Coupons  and  Departmental  Proof 


.     604 


XXXIV    Clearing  Houses 


626 


Definition  of  Clearing  House  Terms 

The  Place  of  Clearing  and  Its  Equipment 

Administration 

Functions 

The  New  York  Clearing  House 

The  Process  of  Clearing 

Making  Settlements 

Clearing  House  Certificates 

Clearing  House  Loan  Certificates 

General  Purpose  of  Loan  Certificates 

Settlement  by  Book  Entries  with  Federal  Reserve  Bank 

Other  Methods  of  Settlement 

Items  that  May  Be  Cleared 

City  Collection  Department 


XX 


CONTENTS 


Chapter 


Page 


Statistical  Work 
Examination  Department 
Co-operative  Competition  of  Members 

XXXV     Country  Collections 651 

Transits  and  Collections  Defined 

Collections  Through  Correspondent  Banks 

Exchange  Rates  and  Collection  Charges 

Effect  of  Collection  Charges 

Country  Clearing  Houses — Organization 

Method  of  Making  Country  Collections 

Advantages  of  Country  Clearing  Houses 

Growth  of  Country  Clearing  Houses 

Nature  and  Allocation  of  Collection  Charges 

Methods  of  Handling  Interest  Charges  on  Collections 

Allocation  of  Exchange  Charges 

Justification  of  Exchange  Charges 

Profits  on  Collections 

Opposition  of  Small  Banks  to  Par  Collection  System 

Elements  of  Collection  Charges 

Existing  Exchange  Charges 

Defects  of  the  Former  System  of  Country  Collections 

XXXVI    The  Federal  Reserve  Collection  System    .     .     .     672 

Growth  of  the  System 

Transit  Items  Collectible  Under  System 

Routing  and  Clearing  of  Items 

Non-Transit  Items  Collectible  Under  System 

Procedure  in  Making  Collections 

Advantages  of  the  Federal  Reserve  Collection  System 

Opposition  to  Federal  Reserve  Collection  System 

The  Universal  Numerical  System 

XXXVII    The  Transit  Department 686 


General    Functions   and    Organization   of    the    Transit 

Department 
Collection  of  Cash  Items — Work  of  Night  Force 
Collection  of  Cash  Items — Work  of  Day  Force 
Collection  of  Non-Transit  Items 
The  Analysis  of  Accounts 
Cost  of  Handling  an  Account 
Profit  on  Handling  an  Account 
Nature  of  Telegraphic  Communications 
Telegraphic  Payments,  Transfers,  and  Deposits 
Cashier's  Checks  and  Exchange  Drafts 
Commercial  Paper  of  Correspondents 
The  Law  of  Collections  and  Acceptance 
Responsibility  of  Collecting  Bank  as  Agent 
Responsibility  for  Selection  of  Agent 
Restrictive  Indorsement  of  Items 
Instructions  for  Collections 


CONTENTS 


XXI 


Chapter 


Page 


Time  of  Presentment  for  Acceptance  or  Payment 
Place  of  Presentment  for  Acceptance  or  Payment 
Person  to  Whom  Presentment  for  Acceptance  or  Pay- 
ment Is  Made 
Protest 
Acceptable  Tender 

XXXVIII    Special  Service  Departments 713 

Gratuitous  Services  by  Banks 
The  Customers'  Securities  Department 
Internal  Organization 
Records  of  Securities  Department 
Miscellaneous  Duties 
Relationship  to  Other  Departments 
The  Statistical  Department 
The  Industrial  Service  Department 
The  Foreign  Trade  Department — The  Commercial  Rep- 
resentative 
Work  of  Home  Organization 

XXXIX    Travelers'  Checks  and  Letter  of  Credit  Depart- 
ment      727 

General  Duties  and  Organization  of  the  Department 
Application  for  Letter  of  Credit 
Typical  Letter  of  Credit 
Identification  of  Holder  of  Letter  of  Credit 
Methods  and  Terms  of  Issuance 
The  Issuance  of  Travelers'  Checks 
Letters  of  Credit  and  Travelers'  Checks  Issued  by  Inte- 
rior Correspondents 
Method  of  Using  Letters  of  Credit 
Method  of  Using  Travelers'  Checks 
Letters  of  Credit  Issued  by  Foreign  Banks 
Records  of  the  Department 


XL    The  General  Bookkeeper's  Department   ...     746 

Importance  of  Bank  Bookkeeping 

Development  of  Accounting  Methods 

Classes  of  Records 

Organization  of  the  General  Bookkeeper's  Department 

The  Cashier's  Check  Book 

The  Expense  Ledger 

Taxes 

Borrowed  Bond  Books 

The  Interest  Balance  Book 

The  Suspense  Ledger 

The  General  Journal 

The  Recapitulation  Book 

The  General  Ledger 


XX11 


CONTENTS 


Chapter 


Page 


The  Statement  Book 
Bank  Reports 
Card  Files 

XLI    The  Auditing  Department 770 

Qualifications  of  Bank  Auditor 

Duties  of  Auditing  Department 

The  Reconcilement  of  Domestic  Accounts 

The  Investigation  of  Domestic  Accounts 

The  Verification  of  Domestic  Accounts 

Reconcilement  and  Investigation  of  Foreign  "Our" 
Accounts 

Reconcilement  and  Investigation  of  Foreign  "Their"  Ac- 
counts and  Verification  of  Foreign  Accounts 

The  Verification  of  Canceled  Coupons 

The  Checking  of  Expense  Bills 

The  Balancing  of  Pass-Books 

The  Filing  of  Statements  and  Checks 

Bank  Examinations 

Manner  of  Conducting  Examinations  Illustrated 


VOLUME  IV— DOMESTIC  BANKING— EARNING  ASSETS 


XLII    The  Discount  Department 813 

General  Functions  and  Organization  of  the  Discount  De- 
partment 
The  Nature  of  Discounting 
The  Nature  and  Care  of  Discounted  Paper 
Rediscounting  of  Bills  Receivable 
Guaranties  in  Lieu  of  Indorsement 
Responsibility  of  Directors  for  Approval  of  Discounts 
Routine  of  Department's  Work 

Advances  and  Rediscounts  with  the  Federal  Reserve  Bank 
Records  in  the  Discount  Department 


XLIII    The  Loan  Department — Loans  to  Stock  Brokers 

General  Functions  of  the  Loan  Department 

Internal  Organization 

Classification  of  Loans  of  Banks  in  the  United  States 

Classification  of  Collateral  Loans 

Stock  Brokers'  Loans 

Method  of  Placing  Loans 

Collateral  for  Loans 

The  Loan  Agreement 

Day  Loans  and  Overcertification 

Day  Loan  Agreement 

Margins  on  Stock  Brokers'  Loans 

Requirements  as  to  Collateral 

Requirements  as  to  Margins 


828 


CONTENTS 


XX1U 


Chapter 


Page 


Collateral  Substitutions  on  Stock  Brokers'  Loans 

Rates  of  Interest  on  Stock  Brokers'  Loans 

Method  of  Determining  Call  Loan  Renewal  Rate 

Dangers  of  System  of  Rate  Determination 

Factors  Influencing  Call  Money  Quotations 

Method  of  Determining  Time  Loan  Interest  Rates 

Daily  vs.  Fortnightly  Clearings 

Relation  of  the  Call  Loan  Rate  and  the  Commercial  Paper 

Rate  of  Interest 
The  Collection  and  Computation  of  Interest 

XLIV    The  Loan  Department — Other  Loans       .... 

Merchandise  Loans  and  Commodity  Paper 

Legal  Protection  of  Merchandise  Loans 

Risks  of  Loans  on  Staple  Commodities 

Substitutions  of  Collateral  on  Merchandise  Loans 

Loans  on  Bills  of  Lading 

The  Rediscount  of  Commodity  Paper 

Handling  the  Collateral  of  Rediscount  Paper 

Loans  to  Banks 

Collateral  and  Margins  of  Bank  Loans 

Examination   and   Substitution   of   Collateral   for    Loans 

to  Banks 
Handling  Applications  for  Loans 
Ratio  of  Loans  and  Balances — Forms  of  Loans 
Time  Limit,  Renewal,  and  Cancellation  of  Loans 
Records  of  the  Loan  Department 
Overdrafts — Disadvantages  of  Practice 
Prevalence  of  and  Remedies  for  Overdrafts 


863 


XLV    The  Law  of  Loans  and  Discounts  and  of  Negotiable 

Instruments       887 

Distinction  Between  Pledge,  Mortgage,  and  Lien 

Relation  of  Pledgor  and  Pledgee 

What  May  Be  Pledged 

Creation  and  Establishment  of  a  Pledge 

Rights  of  Pledgor  and  Pledgee 

The  Keeping  of  the  Pledge 

Redemption,  Termination,  and  Sale 

Warehouse  Receipts — Uniform  Warehouse  Receipts  Act 

Classes  of  Receipts 

Liability  of  Warehouseman 

Satisfaction  of  Warehouseman's  Lien 

Negotiation  and  Tran-fer  of  Warehouse  Receipts 

The  United  States  Warehouse  Act 


XL VI    The  Law  of  Loans  and  Discounts  and  of  Negotiable 

Instruments  (Continued) 913 

Bills  of  Lading — Terms  of  Issuance 
Classes  of  Bills  of  Lading 


XXIV 


CONTENTS 


Chapter 


Page 


Liability  of  Carrier 

Negotiation  or  Transfer  of  Bills  of  Lading 
Buyer's  and  Seller's  Title  to  Goods 
Fraudulent  Use  or  Negotiation  of  Bills 
Statutory  Limitations  on  Loans  and  Discounts 
i.  Loans  on  Bank's  Capital  Stock 

2.  Loans  of  Bank  Examiners 

3.  Loans  to  Officers  and  Directors 

4.  Limits  of  Borrower's  Liabilities  to  Bank 
Determination  of  Borrower's  Liability 
Loans  on  Real  Estate  Security 
Investments  in  Real  Estate  and  Mortgages 
Usury  Laws 

XL VII    The  Credit  Department 935 

General  Functions  of  the  Credit  Department 

Need  for  Credit  Department 

Effect  of  Federal  Reserve  System  on  Credit  Department 

Summary  of  Departmental  Work 

Internal  Organization  of  the  Credit  Department 

Passing  upon  Loans  and  Discounts 

To  Whom  Credit  Information  Is  Furnished 

Credit  Files 

Sources  of  Credit  Information 

1 .  Interviews  with  Borrowers 
Utility  of  Financial  Statements 

2.  Mercantile  Agencies — Organization 
Services  of  Mercantile  Agency 

3.  Interchange  of  Credit  Experience 

4.  Credit  Exchange  Bureaus 

5.  Other  Sources  of  Information 

XL VIII    The  Financial  Statement  as  a  Source  of  Credit 

Information 956 

The  Nature  of  a  Financial  Statement 
Classification  of  Assets  and  Liabilities 
Ratio  of  Current  Assets  to  Current  Liabilities 
The  Analysis  of  Current  Assets 
The  Analysis  of  Current  Liabilities 
The  Analysis  of  Fixed  Assets 
The  Analysis  of  Fixed  Liabilities 
Ancillary  Items 


XLIX     Commercial  Paper  and  the  Discount  Market  .     .     969 

The  Cash  Discount  System  and  Single-Name  Paper 

Two- Name  Paper 

The  Trade  Acceptance — Nature  of 

The  Acceptance  Compared  with  Commercial  Draft 

Relative  Value  of  Two- Name  and  Single- Name  Paper 

Basis  of  Security  of  Commercial  Paper 


CONTENTS  xxv 


Chapter  Page 

The  Open  Account  and  the  Discount  Market 
Open-Market  Borrowing 

Factors  of  Development  of  Open-Market  Borrowing 
Kinds  of  Open-Market  Paper 
The  Note-Broker — Commission  Rates 
Purchases  Through  Brokers — Risks  and  Guaranties 
Advantages  of  Borrowing  Through  Note-Brokers 
Effect  of  Open-Borrowing  on  Banks 
Objections  to  Open-Market  Borrowing 
Volume  of  Open-Market  Borrowing 
The  Registration  of  Paper  Sold  in  Open  Market 
The  Assignment,  Hypothecation,  and  Guaranty  of  Accounts 

Receivable 
Borrowing  from  Commission  House 
Simultaneous  Borrowing  from  Different  Sources 
The    Trade   Acceptance   and    the   American    Acceptance 

Council 
Advantages  of  Trade  Acceptance  to  Buyer 
Advantages  of  Acceptance  to  Seller 
Advantages  of  Acceptance  to  Banking  System 

L    Commercial  Paper  and  the  Discount  Market  (Con- 
tinued)        996 

Bank  Acceptances 
Origin  of  the  Bank  Acceptance 
Development  of  Use  in  the  United  States 
Difference  Between  the  Bank  Acceptance  and  Other  Com- 
mercial Paper 
Factors  Which  Influence  Granting  of  Acceptance  Credits 
Limitations  to  Acceptance  Credits 
Acceptance  Provisions  of  Federal  Reserve  Act 
Use  of  Domestic  Bank  Acceptances  Illustrated 
Functions  and  Purposes  of  Bank  Acceptances 
Eligibility  of  Bank  Acceptances  for  Rediscount 
Forward  Transactions  in  Acceptances 
Factors  Requisite  for  Creation  of  Discount  Market 
Acceptance  Dealers 

Advantages  of  Discount  Market  to  Banking  System 
Rediscounts  with  the  Federal  Reserve  Banks 
Need  for  Standardization  of  Discount  Paper 
Rediscount  of  Promissory  Notes  and  Agricultural  Paper 
Open-Market  Purchases 

LI    The  Bond  Department 102 1 

General  Functions  and  Organization  of  the  Bond  Depart- 
ment 
Bank  Investments  in  Securities 

Powers  of  Commercial  Banks  with  Respect  to  Securities 
Powers  of  National  Banks  with  Respect  to  Securities 
Powers  of  State  Banks  with  Respect  to  Securities 
Transactions  in  Bonds — Stock  Exchange  Procedure 


XXVI  CONTENTS 


Chapter  Page 

Execution  of  Orders 

The  Accounting,  Recording,  and  Custody  of  Bonds  Bought 
The  Bond  Ledger 
The  Bond  Earnings  Book 
Other  Books  of  the  Bond  Department 
Syndicates,  Participations,  and  the  Distribution  of  Original 
Issues 

LII  Operations  of  the  Bank  as  Transfer  Agent,  Regis- 
trar, Fiscal  Agent,  Trustee,  and  Savings 
Institution 1040 

Functions  of  a  Transfer  Agent  and  Registrar 

The  Registration  of  Corporate  Stocks 

Procedure  and  Functions  of  Registrar 

The  Transfer  and  Registration  of  Bonds 

The  Payment  of  Registered  Interest 

Transfer  Agent  for  Corporate  Stocks 

The  Stock  Books  and  Transfer  of  Certificates 

Procedure  in  Transfer  of  Certificates 

Transfers  in  Fiduciary  Capacities 

The  Delivery  of  the  New  Certificates 

The  Stock  Ledgers 

Taxation  of  Transfers 

Proxies 

Subscriptions  to  Capital  Stock 

Compensation  of  Transfer  Agent 

The  Nature  of  a  Paying  or  Fiscal  Agency 

Method  of  Handling  the  Coupons 

The  Trust  Department — Legal  Requirements 

Development  of  a  Trust  Department 

The  Savings  Department 


VOLUME   V— THE  FOREIGN  DIVISION 

LIII    Administration  of  the  Foreign  Division  ....     1083 

Characteristics  of  Foreign  Commerce 

Institutions  Engaged  in  Foreign  Banking  Operations 

The  Nature  and  Development  of  the  Foreign  Division 

The  Management — The  Comptroller 

The  Chief  Clerk  and  the  Assistant  Cashier 

The  Vice-Presidents 

Departmentalization 

LIV    The  Elements  of  Foreign  Exchange 1096 

Foreign  Trade  Balance 

The  Demand  for  Bills  of  Exchange 


CONTENTS  xxvii 


Chapter  Page 

The  Supply  of  Bills  of  Exchange 

The  Reciprocal  Relation  of  Exchange  Rates  in  Two  Markets 
Fluctuations  in  the  Rate  of  Exchange 
Cost  of  Gold  Shipments 
Investment  and  Speculation  in  Exchange 
Method  of  Investment  in  Time  Bills 
Profit  from  Investment  in  Time  Bills 
Hedging  Operations  in  Foreign  Exchange 
Triangular  Exchange  Operations — Arbitrage 
Cable  Exchange 
Sight,  Short,  and  Long  Bills 
Effect  of  Discount  Rates  on  Marketing  of  Bills 
Clean  Bills,  Documentary  Bills,  Trust  Receipts,  and  Bills 

Drawn  Against  Securities 
Commercial  Bills  and  Bankers'  Bills 
Commercial  Letters  of  Credit 
Travelers'  Letters  of  Credit 
Dollar  Drafts  and  Credits 
Short-Term  Loans 
Finance  Bills — Stock  Exchange  Operation 


LV    The  Elements  of  Foreign  Exchange  (Continued)  1135 

Foreign  Exchange  and  Discount  Markets 

Brokers,  Dealers,  and  Discount  Houses 

Commission  Arrangements  Between  Banks 

The  London  Discount  Market 

Discount  Rates  and  Exchange  Rates 

Effect  of  Bank  of  England  Rate  on  Discount  Rates 

The  Control  of  Gold  Movements 

The  Gold  Standard  and  the  Gold  Exchange  Standard 

Gold-Silver  Exchanges 

The  Gold  Exchange  Standard 

Exchange  and  the  Paper  Standard 

Exchange  and  Specie  Embargoes 

Quotation  of  Exchange  Rates 

Quotation  of  Sterling  Exchange 

Quotation  of  Franc  and  Lira  Exchange 

Quotation  of  Mark  Exchange 

Recent  History  of  the  Foreign  Exchanges — The  Inflation 

Factor 
Factors  Influencing  Demand  and  Supply  of  Exchange 
The  Balance  of  Exports  and  Imports  of  Merchandise 
Payments  of  Freight,  Insurance,  Bank  Commissions,  etc. 
Remittances  by  Immigrants 
Travelers 
New  Loans,  Repayment  of  Old  Loans,  and  Repurchase  of 

Securities 
Payments  of  Interest  on  Old  Loans 
Speculative  Purchases  and  Sales  of  Exchange 
Effect  of  War  on  Far  East  Exchange 
Effect  of  War  on  Canadian  Exchange 


xxvm  CONTENTS 

Chapter  Page 

LVI    The  Traders'  Department 1174 

Functions  of  the  Traders — Organization  of  the  Department 

Preparation  of  the  Parity  Sheets 

Method  of  Using  Parity  Sheets 

The  Conference  on  the  Exchanges 

The  Positions 

Actual  Trading 

Form  of  Exchange  Contract 

English  Money  and  Exchange  Calculation 

German  Money  and  Exchange  Calculations 

French  Money  and  Exchange  Calculations 

Calculation  of  Price  of  Documentary  Long  Bills 

Arbitrage  Calculations 

Gold  Shipments  and  the  Calculations  of  Their  Profits 

Transactions  under  Joint  Account 

LVII    The  Foreign  Discount  Department 1200 


Functions  and  Organization  of  the  Foreign  Discount  De- 
partment 
Examination  of  the  Item  at  the  Window 
The  Bills  Register 
The  Remittance  Letter 
Remittance  Letter  Covering  Sterling  Items 
Remittance  Letter  Covering  Dollar  Items 
Passing  on  the  Offerings 
The  Discount  Rate 

Method  of  Payment  for  Items  Purchased 
Settlements  and  Adjustments 
Changing  Discounts  into  Collections 

LVIII    The  Foreign  Tellers'  Department 121 7 

General  Functions  and  Organization 

Distribution  of  the  Incoming  Mail  and  Cables 

The  Foreign  Receiving  Teller 

The  Sale  of  Drafts  on  Foreign  Banks 

The  Sale  of  Foreign  Drafts  by  Interior  Correspondents 

Cable  Transfers 

The  Foreign  Paying  Teller 

The  Foreign  Paying  Tickets 

Payments  by  Cashier's  Check 

Window  Payments 

The  Handling  of  Bought  Contracts 

The  Handling  of  Sold  Contracts 

Investigations 

LIX    Foreign  Collections 1231 

Classification  of  Foreign  Collections 
The  Collection  of  Home  Items 
The  Handling  of  Cash  Items 
The  Handling  of  Collection  Items 


CONTENTS  xxix 


Chapter  Page 

The  Handling  of  the  Discount  Items 

The  Collection  of  Foreign  Items 

The  Receipt  and  Entry  of  the  Items 

The  Tickets  and  Remittance  Letter 

Record  of  the  Items  Between  Transmission  and  Payment 

Payment  of  the  Collection 

LX    Commercial  Letters  of  Credit 1245 

Nature  of  Commercial  Letters  of  Credit 
Advantages  of  Their  Use 
Classification  of  Commercial  Credits 
Authority  to  Purchase 
Dollar  Credits 

Advantages  of  Dollar  Credits 
Terms  of  Issue 

Factors  to  be  considered  in  Arranging  a  Commercial  Credit 
The  Guarantor 

Guaranty  of  Letters  of  Credit  Issued  for  Interior  Correspon- 
dents 
The  Drawer 


LXI    Commercial  Credit  Departments 1264 

Import  Commercial  Credit  Department 

The  Issuance  of  Import  Credits 

Forms  of  the  Application  and  Letter 

Handling  of  Documents 

Handling  the  Bills  of  Exchange 

Preparation  of  the  Tickets 

The  Export  Commercial  Credit  Department 

Method  of  Handling  Exportation  Under  Letters  of  Credit 

Issuance  of  Credits 

The  Departmental  Records 

Acceptances  Under  Export  Credits 

Payments  Against  Documents 

Payments  Against  Warehouse  Receipts 

Advances  Against  Export  Bills 

LXII    Miscellaneous  Departments 1290 

Minor  Departments 

The  Nature  of  the  Foreign  Correspondence  of  a  Bank 

The  Foreign  Incoming  Mail  Department 

The  Foreign  Outgoing  Mail  Department 

Foreign  Registered  Mail 

Incoming  Currency  Shipments 

The  Translators'  Department 

The  Cable  Department 

Foreign  Customers'  Securities  Department 

New  Foreign  Accounts  Department 

Soliciting  and  Opening  New  Accounts 


xxx  CONTENTS 

Chapter  Page 

LXIII    The  Foreign  Bookkeeper's  Department         .     .     .     1305 

General  Duties  of  the  Department 
Miscellaneous  Routine  Duties 
The  Bills  Payable  Bookkeepers 
The  "Their"  Accounts  Books 
The  "Our"  Accounts  Books 
The  General  Ledger 
Other  Books 


FORMS  AND  ILLUSTRATIONS 


VOLUME  I 
Figure  Page 

i.  Graphic  Chart  Showing  Ratio  of  Loans  to  Deposits  of  New  York 

Clearing  House  Banks 82 

2.  Graphic  Chart  Showing  Ratio  of  Cash  Reserves  to  Loans  of  New 

York  Clearing  House  Banks 91 

3.  (a)  Graphic  Chart  Showing  Ratio  of  Loans  to  Aggregate  Assets  of 

All  Banks  Reporting  to  Comptroller 93 

3.  (b)  Graphic  Chart  Showing  Ratio  of  Loans  and  Investments  to  Aggre- 

gate Assets  of  All  Banks  Reporting  to  Comptroller       ....  94 

VOLUME  H 

4.  The  Federal  Reserve  Districts 242 

5.  Proposed  Type  of  Organization  for  the  Federal  Reserve  Banks,  191 8  266 

6.  Official  Organization  of  the  Federal  Reserve  Banks  of  New  York     .  268 

7.  Graphic  Chart  Showing  Reserves  of  the  Twelve  Federal  Reserve 

Banks 363 

8.  Graphic  Chart  Showing  Seasonal  Variations  in  Federal  Reserve  Note 

Circulation 372 

9.  Graphic  Chart  Showing  Earning  Assets  of  the  Federal  Reserve 

Banks,  1914-1920 376 

VOLUME  m 

10.  Ideal  Chart  of  Typical  Bank  Organization 538,  539 

11.  Paying  Teller's  Proof 549 

12.  Deposit  Slip 570 

13.  Second  Teller's  Proof         574 

14.  Rack  Proof  for  Cash  Letters        579 

15.  A.  M.  Assembly  Rack  Proof 582 

16.  Mail  Teller's  Sectional  Proof 584.  585 

17.  Fourth  Teller's  Proof        586 

18.  Check  Clerk's  Sectional  Proof 594 

19.  Check  Clerk's  Trial  Proof 595 

20.  The  Boston  Ledger 597 

21.  Third  Teller's  Proof 611 

22.  Fifth  Teller's  Proof 618 

23.  Proof  of  the  Coupon  Collection  Department 624 

24.  Exchange  Charge  Sheet 693 

25.  Analysis  Sheet  of  Transit  Department 697 

26.  Application  for  Travelers'  Letter  of  Credit 729 

27.  Typical  Travelers'  Letter  of  Credit  in  Use  Before  the  War    .     .  730 

xxxi 


XXXll  FORMS  AND  ILLUSTRATIONS 

Figure  Page 

28.  Typical  Travelers'  Letter  of  Credit  Now  Used 731 

29.  Typical  Pre-War  Travelers'  Check 736 

30.  Typical  Travelers'  Check  Now  Used 738 

31.  Double  Ticket  for  General  Bookkeeper's  Department       ....     762 

32.  General  Journal  Proof 763 

VOLUME  IV 

33.  Loan  Envelope  for  Securities  (face)        838 

34.  Substitution  Ticket 850 

35.  Graph  Showing  the  Usual  Seasonal  Changes  in  Money  Rates,  Based 

on  New  York  Quotations  .  860 

VOLUME  V 

36.  Ideal  Chart  of  a  Foreign  Division 1090 

37.  Chart  Showing  General  Deviation  of  Rates  from  Mint  Pars      .      .  1161 

38.  Graph  Showing  Canadian  Exchange  Rates  at  New  York     .      .      .  11 73 

39.  Parity  Sheet  1178 

40.  Application  for  Commercial  Letter  of  Credit 1268 

41.  Commercial  Letter  of  Credit 1269 

42.  Agreement  Annexed  to  Commercial  Letter  of  Credit       ....  1270 

43.  Trust  Receipt  for  Goods  Shipped  Under  Commercial  Letter  of 

Credit 1272 

44.  Bank's  Liability  Ticket  for  Acceptances  Under  Commercial  Letters 

of  Credit  in  Foreign  Currency 1276 

45.  Bank's  Liability  Ticket  for  Acceptances  Under  Dollar  Credits       .     1276 


Banking  Principles  and 
Practice 


VOLUME  I 

ELEMENTS  OF  MONEY,  CREDIT,  AND 
BANKING 


CHAPTER  I 

METALLIC  MONEY 

Relation  of  Money  and  Banking  Principles 

A  bank  is  an  institution  for  the  custody,  loan,  exchange,  or 
issue  of  money  and  credit,  and  for  facilitating  the  transmission 
of  funds  by  bills  of  exchange.  Banks  deal  in  money  and  in  credit, 
which  is  the  deferred  payment  of  money.  The  principles  of 
banking  therefore  are  inextricably  involved  with  the  principles 
of  money  and  of  credit. 

Money  is  of  two  kinds:  metallic  or  commodity  money,  and 
paper  or  fiduciary  money.  Such  metallic  money  as  is  not  stand- 
ard money  is  also  fiduciary  in  character.  This  and  the  next 
chapter  contain  a  discussion  of  metallic  money,  which  is  followed 
in  Chapters  III,  IV,  and  V  by  a  discussion  of  fiduciary  money — 
a  form  of  credit  issued  by  governments  and  banks  and  character- 
ized by  general  acceptability.  Of  the  many  forms  of  credit  issued 
by  banks  only  bank  notes  enjoy  general  acceptability.  Such 
notes  are  fiduciary  money  in  every  essential,  and  in  some  coun- 
tries they  constitute  the  bulk  of  the  circulating  media.  In  other 
countries  bank  deposits  are  a  more  important  medium  of  ex- 
change, in  spite  of  the  fact  that  their  acceptability  is  restricted. 
Letters  of  credit  and  acceptances  are  also  other  important  forms 
of  non-circulating  bank  credit. 

The  exposition  of  the  nature  and  laws  of  money  and  credit 
contained  in  the  chapters  referred  to  is  an  especially  proper  and 
useful  introduction  to  the  discussion  of  bank  operations  and 
functions  taken  up  in  Chapter  VI.  There  it  is  explained  how  bank 
deposits  and  note  liabilities  arise  in  a  variety  of  ways,  but  chiefly 
through  loans  and  discounts.  By  means  of  such  loans  and  dis- 
counts the  business  of  the  world  is  effectively  carried  on. 

3 


4  MONEY,  CREDIT,  AND  BANKING 

The  last  five  chapters  of  this  volume  deal  with  the  distinguish- 
ing features  of  the  modern  bank  as  regards  both  organization  and 
operation,  the  features  being  discussed  from  the  point  of  view  of 
the  need  in  response  to  which  they  have  arisen.  A  glance  at  the 
titles  of  these  chapters  will  show  that  there  is,  first,  a  need  of 
facilities  for  performing  the  functions  of  deposit,  note  issue  and 
discount,  and,  second,  a  need  of  safeguarding  the  interests  alike 
of  the  bank,  of  its  patrons,  and  of  the  public. 

The  First  Exchanges 

Inasmuch  as  the  principles  of  money  and  banking  are  closely 
related,  it  seems  logical  in  a  study  of  banking  to  inquire  first  into 
the  history  of  exchange  and  the  functions  of  money.  The  first 
exchanges  were  probably  in  kind.  This  method,  known  as 
"barter,"  is  very  primitive,  restrictive,  and  wasteful.  Few  ex- 
changes can  take  place,  for  several  reasons:  the  coincidence  of 
mutual  wants  in  amounts,  time,  and  place  is  unlikely;  certain 
commodities  which  A  may  wish  to  exchange  for  articles  belonging 
to  B  may  not  exist  in  such  units  as  B  may  wish  or  be  willing  to 
take;  A's  surplus  goods  may  exist  at  a  time  when  B  has  no  ex- 
changeable commodities,  although  it  may  be  a  time  when  B  de- 
sires A's  goods,  and  if  A's  goods  are  perishable,  exchange  by 
barter  would  result  in  great  waste;  similar  waste  and  restriction 
would  exist  where  the  surplus  products  of  a  producer  or  com- 
munity were  in  demand  in  another  locality  whose  surplus  pro- 
ducts did  not  coincide  with  the  demand  in  the  former. 

Primary  Functions  of  Money 

The  burden  of  the  method  of  barter  is  reduced  where  some 
commodity  is  quite  generally  in  demand  in  a  society.  The 
possessor  of  surplus  commodities  is  willing  to  accept  this  article 
of  general  demand,  knowing  that  it  can  be  used  later  in  exchange 
for  particular  goods  he  may  then  need  or  desire.  Goods  which  he 
cannot  get  by  direct  exchange  may  thus  be  procured  indirectly. 


METALLIC  MONEY  5 

A  commodity  may  be  in  general  demand  by  reason  of  its  power  to 
satisfy  directly  man's  desires  and  needs;  objects  of  food,  clothing, 
decoration,  and  the  like  do  this.  But  when  once  adopted,  always 
by  an  unconscious  process,  as  a  medium  of  exchange,  the  com- 
modity is  received  and  wanted  primarily  for  its  exchangeability, 
and  a  prime  use  or  function  of  it  is  to  facilitate  exchanges. 
The  commodity  becomes  the  foundation  upon  which  a  new 
economy  rests,  the  economy  of  division  of  labor,  of  separation  of 
employments.  Producers  eventually  produce  articles  to  ex- 
change, not  for  specific  goods  but  for  general  purchasing  power; 
they  specialize  their  production  and  sell  to  a  general  market. 
The  exchange  values  of  their  products  in  terms  of  the  commonly 
acceptable  mediums  are  spoken  of  as  "price";  to  receive  the 
medium  for  goods  is  to  "sell,"  to  give  the  medium  for  goods  is 
to  "buy."  The  medium  is  money  and  may  be  any  commodity 
having  general  acceptability. 

But  a  second  function  is  apparent:  the  values  of  salable  com- 
modities are  measured  and  stated  in  terms  of  this  medium.  The 
comparison  of  values  becomes  possible  when  values  are  expressed 
in  a  common  standard.  Money  becomes  the  common  denomina- 
tor of  value  and,  besides  making  exchanges  easier,  makes  them 
definite. 

For  wants  to  be  wholly  coincident  in  time  is  quite  impossible; 
A  may  not  want  B's  product  at  the  particular  time  that  B  wishes 
to  dispose  of  it.  But  the  exchange  value  may  be  determined  at 
any  time  and  a  contract  drawn  by  which  A  promises  to  pay  B  so 
much  of  the  money  medium  at  a  future  date,  and  in  exchange  for 
this  promise  receives,  at  once  or  when  he  wishes,  B's  product. 
Money,  in  other  words,  becomes  the  standard  of  deferred  pay- 
ments, performing  thereby  its  third  fundamental  function.  The 
seller  is  willing  to  agree  to  accept  the  money,  because  he  is  con- 
fident that  social  custom  will  not  change  meanwhile  and  that  the 
medium  will  still  be  generally  acceptable  in  exchange  for  things 
that  he  may  desire. 


b  MONEY,  CREDIT,  AND  BANKING 

Minor  Functions  of  Money 

In  addition  to  these  three  fundamental  functions  of  money 
there  are  many  minor  functions.  One  of  the  latter,  important  in 
banking,  is  the  storing  of  value  against  emergencies.  As  will  be 
explained  later,  credit-issuers,  such  as  banks  and  governments, 
hold  on  hand  reserves  of  the  money  commodity.  Other  commodi- 
ties may  be  and  are,  directly  or  indirectly,  used  to  store  values; 
the  money  commodity,  however,  by  reason  of  durability,  stable 
value,  and  small  bulk,  may  perform  this  function  better  than 
other  commodities. 

Moreover,  just  as  money  acts  as  a  means  of  storing  values  and 
making  payments  over  periods  of  time,  it  is  used  to  facilitate 
payments  over  distances,  a  capacity  which  rests  upon  money's 
common  acceptability  in  distant  marts  and  upon  its  portability. 
This  function  has  been  very  much  reduced  by  credit  operations, 
but  continues  for  the  settlement  of  ultimate  balances. 

Characteristics  of  Commodities  Used  as  Money 

The  commodities  which  have  been  used  as  money  have  been 
many  and  various,  and  have  possessed  in  varying  degrees  the 
qualities  which  enabled  them  to  perform  all  or  some  of  the  func- 
tions of  money  more  or  less  adequately.  When  any  commodity 
becomes  an  object  of  general  desire  and  acceptability,  it  is  rudi- 
mentary money.  Such  a  commodity  is  therefore  intimately  re- 
lated to  the  social  and  economic  activities  of  the  people.  A  com- 
modity generally  acceptable  in  one  community,  however,  may 
not  be  so  in  another,  and  its  acceptability  in  a  community  may 
not  be  lasting.  For  instance,  wampum  shells,  because  of  their 
general  demand  for  decorative  purposes,  functioned  well  as  money 
among  New  England  Indians,  but  the  influx  of  Europeans  and 
the  changes  in  social  and  economic  life  of  that  district  destroyed 
the  usefulness  of  wampum  as  a  money  commodity. 

To  be  suitable  as  a  circulating  medium,  the  commodity  must 
have  utility  other  than  monetary;  it  must  be  divisible  with- 


METALLIC  MONEY  7 

out  loss  of  value;  it  must  be  portable,  with  relatively  large  value 
in  small  bulk;  it  must  be  malleable  and  recognizable  when 
stamped;  it  must  be  uniform  in  composition  and  quality;  and  it 
must  be  durable  and  able  to  resist  wear  and  tear.  To  serve  as  a 
standard  for  deferred  payments  and  as  a  store  of  value,  its  value 
in  exchange  should  be  as  stable  as  possible;  such  stability  would 
tend  to  result  from  limited  and  steady  production  and  broad 
usage.  All  these  qualities,  and  others  which  might  be  suggested, 
give  to  the  commodity  its  essential  characteristic,  namely,  uni- 
versal exchangeability  in  both  time  and  place. 

Metals  as  Money 

Historically  considered,  the  evolution  of  money  as  a  com- 
modity is  characterized  by  the  tendency  of  metals  to  supersede 
all  other  forms  of  money  in  the  more  advanced  communities,  and 
by  the  tendency  to  progress  from  the  less  valuable  to  the  more 
valuable  metals.  The  result  is  that  gold,  which  possesses  the  de- 
sired qualities  to  a  higher  degree  than  the  other  metals,  has  be- 
come pre-eminently  the  universal  money  article.  The  settlement 
of  big  purchases,  debts,  and  balances  is  made  in  terms  of,  and  by 
the  transfer  of,  gold.  For  certain  purposes,  however — for  example, 
small  transactions — other  metals  are  more  serviceable,  their  lower 
value  making  possible  a  larger  weight  for  small  values.  Hence  in 
the  United  States  the  contemporary  use,  along  with  gold,  of 
silver,  nickel,  and  copper;  these  latter,  however,  are  recognized 
as  subsidiary  to  gold. 

Coinage 

Metallic  money  may  circulate  by  weight  or  by  count.  In  its 
earliest  form  it  circulated  by  weight,  but  the  practice  was  very 
inconvenient.  So  long  as  money  circulated  by  weight,  there  was 
no  misapprehension  as  to  the  nature  of  money — it  was  a  commod- 
ity exchanged  in  kind  for  other  commodities,  and  the  barter  na- 
ture of  the  operation  was  clearly  evident.    To  introduce  circula- 


8  MONEY,  CREDIT,  AND  BANKING 

tion  by  count,  it  was  necessary  for  an  authoritative  person  or 
institution  to  issue  pieces  of  the  metal  uniform  in  size,  content, 
and  design,  and  attest  to  this  uniformity  by  the  imprint  of  his  or 
its  stamp.  Such  pieces  had  to  be  so  designed  as  to  maintain  their 
full  weight.  When  they  were  so  designed,  any  reduction  by  ero- 
sion, sweating,  clipping,  and  the  like,  being  easily  detected,  would 
render  their  acceptance  improbable  except  by  weight.  The  act 
of  manufacturing  uniform  coins  and  stamping  them  in  some  way 
as  a  guaranty  of  their  purity  and  of  their  weight  is  termed 
"coinage." 

The  confidence  of  the  commercial  public  in  these  coins  is  much 
greater  if  the  general  government  does  the  coining,  although  there 
is  no  reason  why  a  private  coiner  cannot  coin  as  competently. 
The  state's  duty  of  enforcing  contracts  and  imposing  penalties, 
and  the  requirements  of  revenue,  caused  the  state  to  safeguard 
the  manufacture  of  a  sound  and  reliable  medium  of  payment. 
Coinage  has  therefore  become  a  state  monopoly,  and  the  legisla- 
tive body  defines  the  name,  weight,  purity,  and  metal  of  the 
different  coins;  and  in  order  to  maintain  the  public  confidence  in 
these  coins,  it  proscribes  all  private  coinage  and  prosecutes 
counterfeiting.  Quite  the  world  over,  coinage  is  vested  in  the 
state. 

Legal  Tender 

One  of  the  necessary  functions  of  government  is  the  adjudica- 
tion and  final  settlement  of  contested  rights  and  contracts;  an- 
other is  the  levy  and  collection  of  revenue  and  the  quittance  of  the 
revenue  payer  from  obligation.  To  perform  these  functions,  it  is 
necessary  for  the  state  to  legislate  as  to  which  coins  of  the  realm 
are  legal  tender  in  payment  of  debts  contracted  in  terms  of  money, 
and  which  are  acceptable  to  the  state  in  settlement  of  revenue 
obligations  and  court  decrees. 

A  legal-tender  law  determines  the  debt-paying  power  of  coins 
and  has  no  reference  to  their  purchasing  power,  which  may  differ 


METALLIC  MONEY  9 

from  their  debt-paying  power.  A  legal-tender  law,  moreover, 
pertains  only  to  debts  contracted  or  decrees  handed  down  in 
terms  of  the  money  in  general,  and  does  not  prevent  contracting 
parties  from  naming  the  specific  money  in  which  payment  is  to 
be  made.  If  a  debtor  offers  a  legal  tender  in  settlement  of  his 
debt,  the  creditor  is  obligated  to  accept  this  or  receive  nothing. 
The  legal-tender  quality  may  be  defined  in  law  as  to  its  extent, 
that  is,  it  may  be  full  and  unlimited,  or  limited.  For  example, 
certain  foreign  coins  may  be  made  legal  tender  at  a  specified  dis- 
count from  their  face  amount,  or,  as  is  the  case  in  the  United 
States,  silver  half-dollars  may  be  made  legal  tender  for  $5  or  less 
in  one  payment. 

Brassage  and  Seigniorage 

The  coinage  laws  of  a  state  also  determine  the  charges  for 
coinage  and  the  freedom  with  which  the  state  will  coin  for  an 
individual  any  bullion  he  may  have  and  wish  coined.  Since 
coins  are  manufactured  articles,  the  actual  expense  of  coinage 
appears  to  be  a  legitimate  charge  to  the  person  bringing  bullion 
for  coining.  Such  charge  is  called  "brassage."  The  state,  how- 
ever, sometimes  uses  its  monopolistic  position  to  charge  more 
than  this  actual  cost.  The  profit  to  the  government  in  such  a 
case  (including  the  brassage)  is  called  "seigniorage"  and  may  be 
so  fixed  as  to  bring  large  returns  to  the  government.  The  charge 
of  high  seigniorage  amounts  to  a  depreciation  of  the  coinage  to 
that  degree,  if  the  government  coins  and  puts  into  circulation 
this  seigniorage.  If  the  state  charges  no  brassage,  it  is  said  to 
have  "gratuitous"  coinage. 

Charging  seigniorage  has  been  resorted  to  for  several  purposes. 
Kings  have  been  known  thus  to  depreciate  the  currency  for  fiscal 
purposes.  To  stop  persons  from  melting  coins,  a  seigniorage 
charge  is  effective,  since  an  ounce  of  coined  metal  is  then  worth 
more  in  exchange  than  an  ounce  uncoined.  Likewise,  to  prevent 
its  exportation,  a  seigniorage  charge  suffices,  since  the  coins  are 


10  MONEY,  CREDIT,  AND  BANKING 

acceptable  in  the  foreign  country  at  only  the  market  value  of  their 
metal  content.  To  keep  down  the  size  of  a  coin  made  from  low- 
value  metal,  a  high  seigniorage  is  effective,  thus  rendering  copper 
cents  and  other  such  coins  convenient  in  size  and  economical  in 
manufacture. 

To  the  degree  that  the  nominal  value  of  a  coin  represents 
seigniorage,  it  becomes  a  fiduciary  form  of  money.  The  holder 
then  depends  upon  the  government,  and  no  longer  upon  the 
market,  to  maintain  the  value  of  his  coin.  In  this  respect  there  is 
no  essential  difference  between  a  silver  dollar,  which  represented 
in  1920  about  25  per  cent  seigniorage,  and  the  greenback,  which 
represents  100  per  cent  seigniorage.  This  phase  of  the  subject  is 
treated  in  Chapter  III. 

The  state  may  proclaim  itself  ready  to  coin  any  amounts  of 
bullion  brought  to  it  by  individuals.  This  freedom  conferred  by 
the  state  is  "free"  coinage.  Under  free  coinage  the  state  may  or 
may  not  charge  brassage;  the  United  States  has,  at  different  times 
in  the  past,  tried  each  plan.  Neglecting  interest  loss,  free  coinage 
with  no  brassage  or  seigniorage  imposed  renders  the  price  of 
bullion  and  coins  practically  the  same,  since  conversion  from  one 
to  the  other  is  open  and  free. 

Bimetallism  versus  Monometallism 

Up  to  and  well  into  the  last  century  the  coinage  systems  of 
progressive  nations  were  bimetallic.  That  is,  there  were:  (1)  free 
and  unlimited  coinage  of  both  gold  and  silver  at  a  fixed  legal  ratio 
of  weights  of  the  gold  and  silver  coins,  and  (2)  the  full  legal  tender 
of  both  at  these  ratios.  The  mint  or  legal  ratio  was  fixed  between 
15:1  and  16:1,  and  conformed  roughly  to  the  market  ratio  pre- 
vailing at  the  time  of  legislation. 

Bimetallism  was  based  upon  the  assumption  that  it  was  de- 
sirable to  continue  the  circulation  of  both  metals  as  primary 
money;  it  was  argued  that  a  higher  stability  of  values  would 
result,  since  price  levels  could  rise  or  fall  only  as  the  combined 


METALLIC  MONEY  II 

volume  of  the  two  metals  rose  or  fell,  and  that  the  probability 
was  small  that  the  two  metals  "would  change  in  value  in  the 
same  direction  and  in  the  same  degree  at  the  same  time."  This 
combining  of  volumes  would  result  in  a  sort  of  compensating 
value — if  silver  were  the  cheaper  metal  on  the  market  it  would 
flow  to  the  mint  and  into  coins;  gold,  on  the  other  hand,  would 
flow  to  the  market  and  be  melted  down.  The  result  would  be  that 
the  market  value  of  silver  would  rise  and  that  of  gold  fall  until 
the  market  ratio  was  again  brought  into  conformity  with  the 
mint  ratio. 

The  gold  standard  assumes  that  gold  alone  is  a  better  and 
more  stable  measure  of  value  than  gold  and  silver  taken  together. 
Under  bimetallism  the  fluctuations  caused  by  shifts,  from  gold  to 
silver  and  from  silver  to  gold,  which  occur  as  the  market  ratio 
adjusts  itself  to  the  mint  ratio,  are  disturbing  to  the  financial  and 
commercial  world.  No  mint  ratio  which  will  bring  permanent 
bimetallism  can  be  determined  upon,  since  the  accidents  of  pro- 
duction and  consumption  of  the  two  metals  may  bring  about  the 
complete  expulsion  of  one  of  the  metals,  in  which  case  monometal- 
lism of  the  other  will  prevail.  Whenever  the  metal  in  a  coin  is 
valued  more  highly  in  the  market  than  at  the  mint,  it  is  either 
melted  or  exported;  the  overvalued  metal  drifts  to  the  mint,  the 
undervalued  to  the  market.  If  the  supply  of  the  overvalued  is 
sufficiently  large,  the  principle  of  compensating  values  which 
tends  to  restore  the  ratio  proves  unavailing  and  the  complete 
expulsion  of  the  undervalued  metal  is  inevitable.  To  keep  a 
bimetallic  system  in  existence  therefore  requires:  (i)  that  the 
mint  ratio  be  changed  from  time  to  time  if  the  mint  and  market 
operations  fail  to  make  the  two  ratios  conform,  and  (2)  that  the 
mint  ratios  adopted  among  the  leading  commercial  nations  agree. 
The  former  requirement  makes  possible  dangerous  disturbances 
at  the  caprice  of  legislators;  the  latter  has  proved  and  is  likely 
to  prove  a  political  impossibility,  on  account  of  the  jealous  and 
independent  attitude  of  each  nation  in  its  monetary  affairs. 


12  MONEY,  CREDIT,  AND  BANKING 

Operation  of  Bimetallism  Illustrated 

To  illustrate  the  compensatory  theory,  suppose  we  had  had 
bimetallism  in  the  United  States  during  the  past  generation.  The 
pure  content  of  the  gold  dollar  is  23.22  grains  Troy,  and  of  the 
silver  dollar  371.25  grains,  these  weights  being  determined  by  the 
coinage  law  and  representing  a  mint  ratio  (371.25  ■*■  23.22  = 
16—)  of  approximately  16:1.  A  Troy  ounce  of  gold  or  silver 
weighs  480  grains  Troy.  Under  bimetallism,  therefore,  at  the 
mint  an  ounce  of  silver  would  be  worth  $1.29  in  gold  (480  ■*■ 
371.25  =  1.29),  and  an  ounce  of  gold  $20.67  m  g°ld  (480  -f- 
23.22  =  20.67);  these  would  be  the  "mint  prices"  and  would  be 
constant,  except  as  Congress  might  legislate  different  weights  for 
the  coins.  With  free  and  gratuitous  coinage  of  gold,  its  market 
and  mint  prices  would  conform,  for  if  the  market  price  of  gold 
bullion  should  fall  to,  say,  $20  per  ounce,  the  holder  of  bullion 
would  carry  it  to  the  mint  and  get  $20.67;  m  other  words,  the 
mint  would  provide  an  unlimited  demand  for  gold  at  $20.67  per 
ounce.  If  the  price  of  bullion  should  rise  to,  say,  $2 1  per  ounce  on 
the  market,  holders  of  coins  would  reduce  them  to  bullion  for  sale. 
In  other  words  the  coined  gold  would  constitute  a  potential  sup- 
ply, as  against  the  industrial  uses  of  gold,  and  keep  the  market 
price  down  to  $20.67.  The  mint  therefore  would  stabilize  the 
price  of  gold. 

The  price  of  gold  is  quoted  in  terms  of  gold,  so  likewise  is  the 
price  of  silver.  The  price  of  silver  will  fluctuate  with  the  acci- 
dents of  its  supply  and  demand.  Suppose  it  fell  to,  say,  $1.20  per 
ounce;  under  the  conditions  of  bimetallism  given  above,  the 
holder  of  bullion  would  prefer  to  sell  it  to  the  mint  at  $1.29  rather 
than  on  the  market  at  $1.20.  In  fact  he  would  use  all  the  pur- 
chasing power  he  could  assemble— gold  coins  and  certificates, 
silver  coins  and  certificates,  bank  notes,  bank  deposits— to  buy 
silver  bullion  on  the  market  at  $1.20  and  then  resell  it  at  the  mint 
at  $1.29;  and  he  would  use  the  proceeds  of  each  sale  to  buy  more 
bullion.    This  demand  for  silver  would  tend  to  raise  its  market 


METALLIC  MONEY  1 3 

price  from  $1.20  to  $1.29,  at  which  price  the  operation  would 
cease  to  be  profitable.  Meanwhile  the  market  ratio  of  the  values 
of  equal  amounts  of  gold  and  silver  bullion  (20.67  +  I-2°  =  17-22) 
would  shift  from  17.22:1  to  16:1. 

Suppose,  on  the  other  hand,  the  market  price  of  silver  had 
risen  to  $1.45  because  of  a  conjunction  of  underproduction  and 
larger  consumption.  Then  it  would  be  profitable  to  reduce  silver 
dollars  to  bullion  and  to  sell  it  at  $1.35  per  ounce.  The  silver  in 
a  silver  dollar  would  then  be  worth  in  the  market  more  (371.25 
■*■  480  X  $1.35  =  $1,044)  than  its  face  value.  The  result  of  this 
process  would  be  that  the  supply  of  silver  bullion  would  increase 
and  its  price  tend  to  fall  from  $1.35  to  $1.29,  and  the  market  ratio 
of  the  values  of  equal  amounts  of  gold  and  silver  (20.67  +  I-35  ~ 
15.3)  would  shift  from  15.3:1  to  16:1. 

It  is  therefore  evident  that  the  establishment  of  bimetallism 
tends  to  make  the  market  price  of  gold  and  silver  alike  conform 
to  the  mint  prices  set  by  law,  and  to  make  their  market  ratio  con- 
form to  their  mint  ratio.  This  conformity  could  not  be  effected 
if,  in  the  first  case  above,  the  silver  mines  were  so  prolific  that  they 
could  keep  the  market  glutted  despite  an  increased  demand,  so 
that  it  would  continue  to  be  profitable  to  carry  bullion  to  the 
mint — for  the  coined  silver  would  entirely  displace  the  gold  and 
silver  monometallism  would  supplant  bimetallism.  Nor  could 
the  conformity  be  effected  if,  in  the  second  case  above,  the  de- 
mand for  silver  were  insatiable,  for  then  silver  would  disappear 
from  circulation  and  gold  monometallism  would  prevail.  Theo- 
retically, however,  for  ordinary  variations  in  the  relative  valua- 
tions of  these  metals,  bimetallism  would  be  an  effectual  conform- 
ing force. 

Effect  of  Two  Legal  Tenders 

The  displacement  of  one  metal  by  the  other,  resulting  in  the 
establishment  of  equilibrium  between  market  and  mint  prices, 
operates  more  exactly  if  both  metals  are  full  legal  tenders  at  the 


14  MONEY,  CREDIT,  AND  BANKING 

mint  ratio.  It  is  the  seller  who  decides  the  form  of  payment  he 
will  accept;  if  asked  to  take  the  coined  metal  overvalued  at  the 
mint,  he  can  refuse  outright,  or  can  accept  it  at  a  discount,  or — 
what  amounts  to  the  same  thing — ask  a  higher  price  for  his  goods. 
In  paying  debts  previously  contracted,  however,  legal  tender  laws 
apply,  and  the  payer  can  tender  any  lawful  money,  and  he  will 
normally  pay  the  metal  which  is  overvalued  at  the  mint.  That 
is,  if  the  silver  dollar  is  a  legal  tender  and  silver  is  selling  on  the 
market  at  $1.20  per  ounce,  a  debt  of  $1  can  be  paid  with  $.928 
worth  of  silver,  by  first  having  the  silver  coined.  The  metal 
overvalued  at  the  mint  tends  to  displace  the  undervalued  and  to 
be  the  circulating  medium.  This  is  Gresham's  Law.  The  legal- 
tender  quality  therefore  helps  to  drive  the  undervalued  metal 
from  circulation,  the  only  prevention  for  which  is  to  specify  in 
the  contract  of  debt  the  tender  that  will  be  acceptable.  Prices 
tend  to  be  quoted  in  the  overvalued  medium  and  therefore  its 
purchasing  power  tends  to  equal  its  debt-paying  power. 

Owing  to  the  higher  price  level,  the  country  becomes  a  good 
one  in  which  to  sell  and  a  poor  one  in  which  to  buy,  the  balance 
of  trade  becomes  adverse,  and  balances  must  be  settled.  In 
international  trade,  where  no  international  legal-tender  laws 
exist,  the  seller  of  goods  determines  the  money  medium  that  is 
acceptable,  and  international  balances  are  normally  settled  in 
gold;  if  the  seller  lives  in  a  silver  or  bimetallic  country,  silver 
may  be  acceptable.  The  supply  and  demand  of  the  metals  is 
therefore  international  in  scope,  and  if  the  mint  prices  of  the 
various  countries  differ  each  metal  will  tend  to  move  to  the  mint 
that  pays  most  for  it.  To  be  successful,  accordingly,  bimetallism 
requires  international  concert  at  fixing  mint  prices. 

The  Limping  Standard 

The  United  States  adopted  bimetallism  in  1792  and  continued 
it  with  more  or  less  success  until  1873  when  the  free  coinage  of 
silver  was  given  up;  after  a  few  years  (1876)  a  limited  coinage  on 


METALLIC  MONEY  1 5 

government  account  with  high  seigniorage  was  adopted.  In  1900 
a  system  of  gold  monometallism  was  undertaken,  but  the  old 
undervalued  coins  were  left  in  circulation.  A  country  thus  hav- 
ing the  concurrent  use  of  two  metals,  one  full  legal  tender  and 
freely  coined,  the  other  full  legal  tender  but  not  freely  coined,  is 
said  to  have  a  "limping  standard." 

Relation  of  Seigniorage  to  Value  of  Coins 

Given  free  coinage,  a  seigniorage  charge  increases  the  value  of 
the  coined  metal  by  the  amount  of  the  seigniorage.  The  state 
either  keeps  a  part  of  the  bullion,  which  it  does  not  coin,  or  it 
holds  back  a  portion  of  the  coined  metal.  So  long  as  the  public  is 
willing  to  accept  the  coins  as  money,  the  value  of  coins  differs 
from  that  of  the  bullion  by  the  amount  of  the  seigniorage. 

The  seigniorage  might  be  taken  out  in  four  ways: 

1.  The  coins  might  be  of  the  same  weight  as  formerly,  but 

the  government  might  not  coin  all  the  bullion  presented ; 
the  toll  of  bullion  is  its  seigniorage. 

2.  Keeping  the  coins  of  the  same  weight  as  formerly,  the 

mint  might  coin  all  the  bullion  presented,  but  not  deliver 
back  all  the  coins;  the  toll  of  coins  is  its  seigniorage. 

3.  The  mint  might  decrease  the  amount  of  bullion  put  into 

the  coins  and  not  coin  the  amount  of  the  bullion  kept  out. 

4.  It  might  decrease  the  amount  of  bullion  put  into  the  coins, 

and  coin  all  the  bullion,  but  hold  back  part  of  the  coins. 

The  first  and  third  methods  would  not  increase  the  number  of 
coins  in  use;  the  second  and  fourth  would  both  increase  the  num- 
ber of  coins  and  raise  the  price  level. 

But  the  entry  of  seigniorage,  especially  when  large,  into  the 
coins  of  a  country  presupposes  that  the  public  has  faith  in  the 
government.  So  long  as  the  public  allows  the  government  to  ex- 
tract the  seigniorage  and  continues  to  accept  the  coins  generally 
as  before,  the  light-weight  coins  will  perform  all  the  monetary 


16  MONEY,  CREDIT,  AND  BANKING 

functions  as  well  as,  or  better  than,  the  heavier  coins.  Assuming 
this  public  confidence,  the  determination  of  the  amountof  seignior- 
age is  an  arbitrary  matter  for  the  government.  The  percentage 
of  seigniorage  may  range  from  o  to  ioo  per  cent.  There  is  no 
essential  reason  why  the  amount  of  metal  in,  say,  the  dime  might 
not  be  more  or  less  than  it  is  at  present;  that  is,  there  is  no  essen- 
tial reason  why  the  government  should  not  take  more  or  less 
seigniorage  than  it  now  does,  provided  the  public  continues  to 
accept  the  coins  as  before. 

Means  of  Maintaining  Public  Confidence   ' 

One  means  by  which  the  government  can  maintain  public 
confidence  is  to  limit  the  number  of  coins  issued;  the  number  of 
any  particular  coin  issued  bears  a  somewhat  steady  relation  to 
the  volume  of  transactions  conducted  with  it  at  the  existing  price 
level.  The  number  of  dimes,  for  example,  which  are  needed  is 
determined  by  the  social  and  business  activities  and  methods  of 
the  community  under  the  prevailing  price  level.  So  long  as  the 
mint  uses  discretion  and  increases  the  number  of  these  coins  only 
in  conformity  with  the  people's  needs,  the  coins  will  be  generally 
acceptable  however  high  the  seigniorage.  Excessive  or  too  sudden 
issues  may  shake  the  popular  faith  in  the  future  general  accepta- 
bility of  these  coins  and  lead  either  to  refusals  to  accept  or  to 
acceptance  only  at  a  discount. 

It  is  evident  that  the  government  could  not  control  the  issues 
of  these  coins  at  a  fixed  seigniorage  if  there  were  free  coinage,  for 
free  coinage  throws  the  control  of  the  coinage  supply  into  the 
hands  of  bullion-holders.  Consequently  when  the  United  States 
government  gave  up  bimetallism  but  continued  to  coin  silver,  a 
new  system  for  regulating  silver  coinage  was  adopted.  Since 
1853,  whenever  any  subsidiary  coins  have  been  minted  they  have 
been  made  from  bullion  bought  by  the  government  on  the  market 
at  the  prices  prevailing  there,  the  difference  between  the  market 
value  and  the  coined  value  constituting  the  seigniorage. 


METALLIC  MONEY  1 7 

A  second  method  of  maintaining  public  confidence  in  high 
seigniorage  coinage  is  to  fix  its  legal-tender  quality.  To  give  the 
recipient  confidence  in  his  ability  to  get  rid  of  it,  it  is  made  legal 
tender,  but  to  protect  the  creditor  from  inconvenience  and  great 
loss,  the  legal  tender  is  limited  to  certain  maximum  amounts  in 
any  one  payment.  A  third  method  is  to  make  it  by  law  convert- 
ible into,  or  redeemable  in,  standard  money,  and  for  this  purpose 
to  maintain  a  reserve  as  evidence  of  the  government's  ability  and 
willingness  to  carry  out  its  promise. 

In  summary,  the  characteristics  of  a  subsidiary,  token,  and 
fiduciary  coinage  are  high  seigniorage,  limited  issue,  limited  legal 
tender,  convertibility  into  standard  money,  and  public  confidence 
in  the  issuing  government. 


CHAPTER  II 

HISTORY  OF  THE  NATIONAL  COINAGE 

First  Coinage  Act 

The  first  Coinage  Act  of  the  United  States  was  prepared  by 
Alexander  Hamilton  in  1792.  It  provided  for  the  establishment 
of  a  mint  and  a  bimetallic  system  of  gold  and  silver  at  a  15:1 
ratio;  it  named  the  coins — eagles,  half-  and  quarter-eagles,  dollars, 
half-  and  quarter-dollars,  dimes  and  half-dimes,  cents  and  half- 
cents — and  the  weights,  metal,  and  fineness  of  each,  as  well  as  the 
devices.  The  dollar  was  made  the  unit  and  defined  as  371^4 
grains  of  pure  silver.  Coinage  was  gratuitous  and  free,  without 
preferences  as  to  bullion-bringers.  All  the  gold  and  silver  coins 
were  full  legal  tender  for  all  debts  whatsoever.  In  1793,  rates 
were  established  at  which  foreign  coins  circulating  in  the  United 
States  would  be  legal  tender.  Coinage  of  silver  was  begun  in 
1794  and  of  gold  in  1795,  and  the  legal-tender  quality  of  foreign 
coins  ceased  at  different  dates  as  proclaimed  by  the  President  or 
enacted  by  Congress. 

Changes  in  the  Mint  Ratio 

The  15:1  ratio  as  ascertained  by  Hamilton  was  soon  found  to 
be  too  low.  The  French  had  a  higher  ratio,  15.5:  1,  and  gold 
flowed  to  France  where  its  coinage  value  was  higher.  Silver  only 
was  coined,  and  much  of  that  was  exported  to  South  America. 
Bimetallism  gave  place  to  silver  monometallism.  In  1834  Con- 
gress attempted  to  restore  bimetallism  by  readjusting  the  mint 
ratio;  the  gold  dollar,  which  had  weighed  one-fifteenth  of  371.25 
grains,  or  24.75  grains,  was  reduced  to  23.2  grains,  or  one- 
sixteenth  of  371.25.  This  was  a  7  per  cent  debasement  of  gold, 
but  probably  it  was  better  thus  to  favor  the  debtor  class  than  to 

18 


HISTORY  OF  THE  NATIONAL  COINAGE 


19 


favor  the  creditor  class  by  increasing  the  weight  of  the  silver 
dollar  until  the  mint  ratio  equaled  the  market  ratio.  In  1837  the 
fineness  of  gold  and  silver  coins  was  made  uniform,  at  nine-tenths, 
and  the  ratio  was  thus  slightly  changed  until  it  stood  at  15.98: 1, 
where  it  still  stands. 

But  this  new  ratio  overvalued  gold.  As  gold  could  be  profit- 
ably brought  from  France,  silver  coins  were  melted  or  transported 
abroad,  gold  drifted  to  the  mints,  and  gold  monometallism  re- 
sulted. In  1853,  to  preserve  the  fractional  silver  coinage,  the 
weights  of  the  half-dollar,  quarter,  dime,  and  half -dime  were 
reduced,  their  legal- tender  quality  limited  to  $5,  and  their  free 
coinage  stopped. 

Thereafter,  when  new  issues  of  subsidiary  silver  were  found 
necessary,  the  mint  was  empowered  to  purchase  bullion  in  the 
market  and  coin  it,  charging  the  profits  from  seigniorage  to  the 
Treasurer  of  the  United  States.1  It  was  now  unprofitable  either 
to  melt  or  export  subsidiary  silver,  since  coined  silver  was  over- 
valued by  the  amount  of  the  seigniorage.  Between  1834  and 
1853  gold  was  increasingly  the  circulating  metal. 


Coinage  of  the  Silver  Dollar 

Between  1861  and  1879  greenbacks  took  the  place  of  metals; 
the  silver  dollar  had  not  been  coined  since  1834,  and  when,  in 
1873,  the  coinage  laws  were  reconstructed,  the  silver  dollar  was 
omitted  from  the  list  of  coins.    This  act  later  became  known  as 


1  United  States  Coinage  Before  1878 
(In  millions)* 


Periods 

Gold 

Silver  Dollars 

Subsidiary  Silver 

1703-1805 
1806-1834 
1835-1852 
1853-1877 

$        2.5 

13-2 
221.0 

774-1 

Jl, 010.9 

$1.4 

1.0 
5.5 

$8.0 

$     0.5 

37-8 

38.4 

1 06. 1 

Total . 

£182.9 

*  In  this  table  and  similar  tables  presented  in  millions,  figures  to  the  right  of  the  hundred 
thousand  column  have  been  disregarded,  alike  in  items  and  totals. 


20 


MONEY,  CREDIT,  AND  BANKING 


the  "Crime  of  '73,"  and  it  was  alleged  by  silver  men  to  be  an 
intentional  omission  so  as  to  demonetize  silver.  All  independent 
investigations,  however,  agree  that  no  such  ill  purpose  was  in  the 
mind  of  Congress.  Bimetallism  in  the  United  States  thus  ceased 
in  law;  it  had  existed  only  in  law  for  two  score  years. 

Between  1871  and  1874  free  coinage  of  silver  was  stopped  in 
many  European  countries  and  big  mines  were  discovered  in  Ne- 
vada. The  narrowing  market  and  suddenly  increased  production 
caused  a  remarkable  fall  in  the  market  value  of  silver.  It  became 
profitable  to  coin  silver  dollars  again,  but  the  mint  had  been  closed 
to  silver  by  the  Act  of  1873 .  For  the  next  three  decades  the  silver 
and  debtor  interests  struggled  for  the  remonetization  of  silver.  A 
series  of  compromises  followed.  In  1878  the  Bland-Allison  Act 
authorized  the  coinage  of  standard  silver  dollars  and  made  them 
full  legal  tender;  the  Secretary  of  the  Treasury  was  to  buy  in  the 
market  not  less  than  $2,000,000  worth  nor  more  than  $4,000,000 
worth  of  silver  bullion  per  month,  and  have  it  coined  into  such 
dollars,  and  pay  the  seigniorage  into  the  Treasury.  Between  1878 
and  1890,  $378,168,000  in  silver  were  coined  at  a  seigniorage  of 
nearly  $70,000,000. 2 


2  Purchases  of  Silver  Under  the  Act  of  1878 


Fiscal  Years 


1878 
1879 
1880 
1881 
1882 
1883 
1884 
188s 
1886 
1887 
1888 
1889 
1890 
1891 


Total. 


Fine  Ounces 
(In  millions) 


10.8 
19.2 
22.0 
19.7 
21. 1 
22.8 
21.9 
21.7 
22.6 
26.4 
253 
26.4 
27.8 
2.7 

291.2 


Cost 
(In  millions) 


$  130 
21.  s 
25.2 
22.3 
24.0 
25-S 
24-3 
23.7 
23.4 
25-9 
24.2 
24.7 
26.8 
3-0 

$308.2 


Average  Price 
per    Fine    Ounce 


$1.0583 


Coinage  of  Silver 

Dollars 

(In  millions) 


The  seigniorage  =  $378,168,793  —  $308,279,260.71  =  $69,887,532.29 


$  8.5 
27.2 
279 
27.6 
27.7 
28.1 
28.0 
28.5 
29.8 
332 
32.7 
33-7 
35-9 
8-7 

$378.1 


HISTORY  OP  THE  NATIONAL  COINAGE 


21 


In  1879  the  subsidiary  silver  was  made  redeemable,  in  mul- 
tiples of  $20,  in  lawful  money,  and  made  legal  tender  in  sums  not 
exceeding  $10. 

In  1890  the  Sherman  Silver  Act  directed  the  Secretary  of  the 
Treasury  to  buy  in  the  market  silver  bullion  aggregating  4,000,000 
ounces,  or  as  much  thereof  as  was  offered  at  less  than  the  mint 
price,  and  to  issue  for  it  treasury  notes  of  the  United  States. 
These  notes  were  made  redeemable  in  coin  by  the  Treasury  on  de- 
mand and  were  reissuable  and  full  legal  tender.  This  act,  which 
repealed  the  Act  of  1878,  contains  the  famous  parity  clause,  which 
pledged  the  United  States  Treasurer  to  maintain  the  two  metals 
on  a  parity  with  each  other  at  the  legal  ratio.  No  method  was 
prescribed  for  the  accomplishment  of  this  pledge  by  the  Secre- 
tary. Provision  was  also  made  for  the  coinage  of  part  of  this 
bullion.  After  three  years'  operation  and  the  coinage  of  $187,000,- 
000,  this  compulsory  purchase  clause  was  repealed. 3 

In  summary,  the  amount  of  silver  dollars  coined  under  the  Act 
of— 

April  2,  1792,  was $     8.0  millions 

February  28,  1878,    " $378.1  millions 

July  14,  1890,    " 187.0 

March        3,  1891,    " 5.0        "  570.2 

Total $578.3      " 

3  Purchases  of  Silver  Under  the  Act  of  1890 


Fiscal  Years 

Amount  of  Silver 

Purchased  _ 
(Ounces  in  millions) 

Cost,    or    Amount 
of  Treasury 
Notes  Issued 
(In  millions) 

Average  Price 
per  Fine  Ounce 

Silver  Dollars 

Coined  from  Bullion 

of  Act  of  1890 

(In  millions) 

1801 
1892 
1^93 
1894 

48.3 
54-3 
54-0 
1 1.9 

1  so.s 

Si. 1 

45-5 

8.7 

$i.04Si 
.9402 
.8430 
•7312 

$27.2 
34 
5-3 
0.0 

168.6 

$iSS-9 

$  -9244 

$36.1 

If  and  when  this  silver  is  coined  into  standard  silver  dollars,  the  seigniorage  will  equal 
(168.6  X  480  +  37iJi)  —  155-9  -  $62  millions. 


22  MONEY,  CREDIT,  AND  BANKING 

Gold  Standard  Act 

The  silver  movement  came  to  a  crisis  in  the  election  of  1896, 
and  in  1900  was  finally  settled  by  what  has  come  to  be  known  as 
the  Gold  Standard  Act.  This  act  fixed  the  gold  dollar,  weighing 
25.8  grains  of  standard  gold,  nine-tenths  fine,  as  the  standard 
unit  of  value,  and  provided  that  "all  forms  of  money  issued  or 
coined  by  the  United  States  shall  be  maintained  at  a  parity  of 
value  with  this  standard,"  and  that  "it  shall  be  the  duty  of  the 
Secretary  of  the  Treasury  to  maintain  such  parity."  The  manner 
of  keeping  gold  and  silver  at  par  is  not  defined,  but  the  probable 
operation  of  the  Treasury  would  be  to  stand  ready  to  redeem  one 
with  the  other. 

The  Pittman  Act 

In  1 918  the  adverse  balance  of  trade  between  the  United 
States  and  India,  in  the  face  of  the  necessity  of  conserving  and 
fortifying  our  gold  reserves  during  the  war,  led  to  the  passage  of 
the  Pittman  Act,  which  authorized  the  Treasury  to  reduce  silver 
dollars,  in  number  not  to  exceed  $350,000,000,  to  bullion  and  to 
sell  it  at  a  minimum  price  of  $1  per  fine  ounce.  At  the  same  time 
the  Secretary  was  authorized  to  enter  into  contracts  with  pro- 
ducers of  silver,  to  buy  silver  at  the  price  of  $1  per  fine  ounce 
for  the  purpose  of  restoring  the  bullion  taken  from  the  Treasury 
and  sold  to  exporters  to  India. 

The  object  of  the  sales  and  purchases  arrangement  was  tem- 
porarily to  provide  silver  in  large  quantities  for  immediate  use. 
The  hoard  of  silver  in  the  Treasury  was  thus  seized  upon  to  settle 
the  adverse  trade  balance  and  conserve  the  gold  supply  against 
shipment  to  the  East.  As  most  of  the  silver  dollars  were  being 
circulated  by  silver  certificates,  the  reduction  of  silver  dollars  to 
bullion  forced  the  recall  of  an  equivalent  amount  of  certificates. 
To  provide  against  the  reduction  of  the  currency  in  this  manner, 
the  federal  reserve  banks  were  enabled  to  issue  federal  reserve 
bank  notes  secured  by  treasury  certificates  of  indebtedness  and 


HISTORY  OF  THE  NATIONAL  COINAGE  23 

one-year  treasury  notes.  These  federal  reserve  bank  notes  will  be 
retired  later,  according  to  the  plan,  by  the  issue  of  silver  certifi- 
cates as  silver  is  repurchased  by  the  Treasury. 

The  Secretary  of  the  Treasury  in  executing  the  Pittman  Act 
decided  that,  in  order  to  provide  for  the  various  items  of  expense 
involved  in  the  operations  of  withdrawing  silver  dollars  and 
recoining  new  bullion,  it  was  necessary  to  fix  the  price  of  silver 
sold  by  the  Treasury  at  $1 .01 5  per  fine  ounce.  Silver  exportations 
were  subjected  to  licenses,  and  any  silver  for  which  more  than 
$1,015  had  been  paid  by  the  applicant  was  denied  export  license. 
These  restrictions  on  silver  exports  were  removed  in  May,  1919. 
In  the  interim  271,000,000  silver  dollars  were  melted  and  sold  at 
$1,015  per  ounce,  although  the  market  price  of  silver  ranged  much 
higher.  In  the  spring  of  1920  the  market  price  of  silver  fell  below 
$1  per  ounce,  and  on  May  17  the  Secretary  of  the  Treasury  gave 
standing  orders  to  the  Director  of  the  Mint,  under  the  mandatory 
provisions  of  the  Pittman  Act,  to  purchase,  at  $1  per  ounce,  silver 
— the  production  of  mines  and  reduction  plants  located  in  the 
United  States — up  to  an  aggregate  amount  of  207,000,000  ounces. 
This  will  establish  a  minimum  price  of  $1  per  ounce  for  American 
silver  for  some  time  to  come,  but  the  price  of  foreign  silver  may 
fall  below  that  figure.  In  February,  192 1,  was  resumed  the 
coinage  of  silver  dollars,  of  which  none  had  been  minted  since 
1905. 

Other  Coinage  Laws 

The  Act  of  1906  provided  for  the  redemption  of  copper  and 
nickel  coins  in  lawful  money,  when  presented  in  sums  of  not  less 
than  $20.  When  they  are  presented  for  redemption  in  such  quan- 
tity as  to  indicate  that  they  are  redundant,  the  Treasury  orders 
their  coinage  temporarily  to  be  stopped.  Numerous  other  coin- 
age laws  of  minor  importance  have  been  enacted,  but  the  above 
constitute  the  fundamental  history  of  our  coinage.  Coinage  is 
sometimes  held  to  include  the  making  of  gold  and  silver  bars. 


24  MONEY,  CREDIT,  AND  BANKING 

Bullion  Bars 

Gold  bars  are  carried  by  the  banks  for  the  convenience  of  their 
customers  in  the  city  or  elsewhere,  and  are  shipped  upon  request. 
Gold  bullion  as  held  in  banks  bears  the  official  stamp  of  the  United 
States  Mint  or  assay  office.  This  stamp,  like  that  on  the  coins,  is 
the  government  attest  of  the  weight  and  purity  of  the  bars.  Besides 
the  official  seal,  weight,  value,  and  fineness,  all  bars  are  stamped 
with  the  bar  and  lot  number.  They  are  weighed  to  the  one- 
hundredth  part  of  an  ounce,  and  are  computed  by  the  fineness  at 
$20.671834625  per  ounce  for  pure  gold.  Small  gold  bars  are  made 
with  values  ranging  from  $105  to  $600;  these  are  used  exclusively 
for  domestic  purposes  and  are  not  exported.  The  bars  in  a  certain 
New  York  bank's  vaults  on  a  certain  date,  for  example,  ranged  in 
weight  and  value  from  5.14  ounces  and  $106.19  value,  to  525.6 
ounces  and  $10,849.61  value.  The  larger  bars  are  used  almost 
exclusively  for  shipment  abroad  and  the  smaller  ones  for  reserve 
and  industrial  purposes. 

Certain  bar  charges,  as  given  in  the  following  table,  are 
imposed  by  the  government  to  cover  the  cost  of  making; 
these  vary  with  the  fineness  and  size  of  the  bar.  Bar  charges  as 
below  are  imposed  when  bars  are  sold  or  when  a  depositor  re- 
quests, directly  or  indirectly,  special  sized  bars  in  payment  of  a 
deposit  of  bullion.  Gold  bars  may  be  sold  only  when  of  standard 
fineness  or  higher,  for  gold  coin  or  gold  certificates  only,  and  in 
lots  of  not  less  than  $5,000.  Silver  bars  may  not  be  sold  except 
upon  special  authorization. 


Gold  Bar  Charges 

Bars  of  $5,000  in  value  and  over 

Bars  of  less  than  $5,000  to  $500,  assorted  sizes . 

Bars  of  less  than  $500,  assorted  sizes 

Bars  between  $300  and  $200,  in  lots  of  20  bars . 
Bars  of  a  fineness  of  999.9,  not  over  $5,000.  .  .  . 
Bars  of  a  fineness  of  999.9,  over  $5,000 


Per  $100  Value 
$.05 

•°S 
.07 
.09 
.09 
.08 


HISTORY  OF  THE  NATIONAL  COINAGE  25 

Silver  Bar  Charges 

Bars  of  standard  silver $.005 

Bars  of  fine  silver,  not  less  than  500  ounces .001 

Bars  of  fine  silver,  between  125  and  500  ounces .00125 

Bars  of  fine  silver,  125  ounces  or  less -0025 

Bars  of  unparted  silver -0025 

Foreign  Shipments  of  Gold 

When  obtainable,  bullion  is  preferred  for  shipment  abroad, 
but  as  a  rule  the  supply  of  large  bars  is  more  or  less  limited. 
When  shipments  are  heavy,  gold  coins  of  the  denomination  of  io's 
and  20's  are  used,  preference  being  given  to  the  latter,  as  they  are 
likely  to  average  better  and  the  loss  from  abrasion  is  not  so  great. 
In  shipping  gold  coin  abroad,  credit  is  given  for  the  actual  weight 
of  the  gold  and  not  the  nominal  value.  Each  of  the  various  de- 
nominations of  gold  coins  is  put  up  by  the  United  States  Mint  in 
bags  of  $5,000  each,  the  standard  weight  of  which  is  268.75 
ounces  Troy,  or  about  18.5  pounds  avoirdupois;  but  many  bags 
weighing  less  are  current,  and  any  such  bag  is  likely  to  contain 
many  coins  below  the  limit  of  tolerance,  that  is,  coins  which  have 
lost  their  legal-tender  quality  because  of  deficient  weight.  As 
these  short-weight  coins  are  not  current,  they  are  stamped 
"light"  by  the  government,  and  must  then  be  sold  as  bullion, 
the  loss  varying  from  ^  to  1  per  cent. 

Gold  Coins  in  Circulation 

The  United  States4  gold  coins  in  circulation  now  are  the 
double  eagle,  the  eagle,  half-eagle,  and  quarter-eagle,  containing, 
respectively,  $20,  $10,  $5,  and  %2x/2.  The  gold  dollar,  though  no 
longer  coined,  was  made  the  standard  unit  of  value  in  1900,  and 
since  1837  has  contained  25.8  grains  .9  fine,  or  23.22  grains  pure 
gold.  An  ounce  of  standard  gold,  therefore,  will  make  18.6 
dollar  coins,  or  be  worth  $18.60,  and  an  ounce  of  pure  gold  will 

*  For  details  as  to  the  United  States  coinage  law,  weights,  fineness,  pieces,  value,  and 
totals  coined,  see  Report  of  Director  of  the  Mint,  in  Treasury  Annual  Report,  1918.  p.  689. 


26  MONEY,  CREDIT,  AND  BANKING 

make  20.67  coins,  or  be  worth  $20.67.  The  government  has 
minted  other  gold  coins  than  the  above  mentioned,  but  they  are 
not  in  general  circulation  and  command  a  premium  as  souvenirs. 
They  are  as  follows :  the  $3  gold  piece,  coined  by  act  of  Congress  in 
1853  and  discontinued  in  1890,  the  weight  of  which  was  74.4 
grains;  the  $1  gold  piece,  coined  first  in  1849  and  discontinued  in 
1890,  which  was  of  two  sizes,  large  and  small,  but  with  the  same 
gold  content;  the  three  issues  of  souvenir  gold  dollars,  the  first  in 
1902  to  commemorate  the  Louisiana  Purchase  Exposition  held  at 
St.  Louis,  in  which  issue  two  different  coins  were  minted,  one 
with  a  Jefferson  head  and  the  other  with  a  McKinley  head;  the 
second  in  1904  for  the  Lewis  and  Clark  Exposition  held  at  Port- 
land, Ore.;  and  the  third  in  191 5  for  the  Panama-Pacific  Interna- 
tional Exposition.  Only  a  limited  number  of  these  special  coins 
were  minted  and  they  were  sold  at  a  premium  for  the  benefit  of 
their  respective  expositions.  In  191 6  special  $1  gold  pieces  were 
issued  for  the  McKinley  Memorial. 

Silver  Coins  in  Circulation 

The  silver  coins  of  the  United  States  now  current  are  dollars, 
half-dollars,  quarters,  and  dimes.  Silver  dollars  were  first  coined 
in  1794  under  the  Act  of  1792,  and  weighed  416  grains  .089  fine, 
or  371.25  grains  pure;  in  1837  the  fineness  was  made  .9  and  the 
weight  reduced  to  412^2  grains,  but  keeping  the  pure  silver  con- 
tent at  371/4-  The  coinage  of  silver  dollars  was  discontinued  in 
1873,  resumed  in  1878,  discontinued  in  1904,  and  again  resumed 
in  1921. 

The  subsidiary  silver  coins  (halves,  quarters,  dimes,  and  half- 
dimes)  date  from  1794  and  contained  their  respective  proportions 
of  the  silver  dollar.  In  1853  their  weights  were  reduced  from 
412^  grains  to  384  grains  for  two  halves,  or  four  quarters,  or  ten 
dimes.  All  silver  dollars,  halves,  quarters,  and  dimes  are  put  up 
by  the  mint  in  bags  containing  $1,000  each,  a  bag  of  the  dollar 
coins  weighing  71.61  and  of  the  fractional  coins  66.98  pounds  Troy. 


HISTORY  OF  THE  NATIONAL  COINAGE  27 

The  commercial  value  of  silver  rose  very  much  during  the  war, 
due,  among  other  things,  to  the  relative  cessation  of  production  in 
Mexico  and  elsewhere,  its  greater  monetary  use  as  a  substitute  for 
gold  coinage  in  belligerent  countries,  shipment  to  India  to  settle 
trade  balances,  and  special  uses  for  war  purposes ;  hence  the  silver 
content  in  the  silver  dollar  rose  in  value  and  the  government's 
seigniorage  correspondingly  decreased.  The  reverse  effects  oc- 
curred during  1920  and  192 1  as  the  price  of  silver  fell  again  to  its 
former  level. 

Other  Issues  of  Silver  Coin 

Various  other  silver  coins  have  been  issued.  The  trade  dollar, 
issued  by  the  Act  of  1873,  weighed  420  grains,  or  7.5  grains  more 
than  the  standard  dollar.  Though  intended  only  for  circulation 
in  the  Orient,  the  trade  dollars  circulated  freely  in  our  own  coun- 
try because  when  the  price  of  silver  fell  it  became  profitable  to 
take  420  grains  of  standard  silver  to  the  mint  and  have  it  minted 
into  a  circulating  coin.  With  a  view  to  stopping  this  circulation, 
their  legal- tender  quality  was  taken  from  them  in  1876,  and  the 
Secretary  of  the  Treasury  was  authorized  to  limit  their  coinage, 
from  time  to  time,  to  such  an  amount  as  he  might  deem  sufficient 
for  the  export  demand.  This  he  did  in  1877,  after  $30,710,400 
had  been  issued.  In  1887  they  were  retired  and  discontinued. 
Special  souvenir  silver  dollars,  known  as  the  "Lafayette  dollar," 
were  coined  to  commemorate  the  Pan-American  Exposition  at 
Buffalo  in  1899.  In  1892  and  1893  a  limited  number  of  souvenir 
Columbian  halves  and  Isabella  quarters  were  coined.  By  the  law 
of  19 18,  provision  is  made  for  coining  100,000  silver  half-dollars 
of  special  design,  commemorating  the  centenary  of  the  admis- 
sion of  Illinois  into  the  Union.  Similar  laws  were  passed  in 
1920  for  Maine  and  Alabama;  and  the  coinage  of  300,000 
half-dollars  commemorating  the  landing  of  the  Pilgrims  was 
also  authorized.  In  addition  to  these  silver  coins,  the  follow- 
ing have  also  been  coined  for  circulation:  the  20-cent  piece, 


28  MONEY,  CREDIT,  AND  BANKING 

1875-1878;   the  half-dime,   1792-1873;   and   the  3-cent  piece, 
1851-1873. 

Nickel  and  Copper  Coins 

The  nickel  5 -cent  pieces  of  the  present  were  first  coined  under 
the  Act  of  1866.  They  are  composed  of  75  per  cent  copper  and 
25  per  cent  nickel,  and  weigh  77.16  grams.  The  cent  dates  from 
1792,  the  earliest  being  pure  copper  and  weighing  168  grains, 
while  those  of  the  present  time  are  bronze  which  is  95  per  cent 
copper  and  5  per  cent  tin  and  zinc,  and  weigh  48  grams.  Between 
1857  and  1864  the  cent  was  of  a  nickel  composition,  88  per  cent 
copper  and  12  per  cent  nickel;  these  coins  are  frequently  found  in 
circulation  at  the  present  time.  Other  minor  coins  issued  have 
been:  the  nickel  3-cent  piece,  1865-1890;  the  bronze  2-cent  piece, 
1864-1873;  and  the  copper  half-cent,  1796-1857. 

The  above  lists  contain  the  legal  United  States  coinage.  In 
addition  certain  coins  have  been  issued  by  private  persons — for 
instance,  the  50-cent  and  25-cent  pieces  issued  in  California. 

Statistical  Statement  of  the  Coinage 

The  present  United  States  coinage  is  as  follows : s 

Weights  and  Fineness  of  Coins 

Double  eagle  ...  Gold  $20.00  464.400  grains  pure  516.00  grains  standard 

Eagle "  10.00  232.200      "       "  258.00 

Half-eagle "  5.00  1 16.100       "        "  129.00       " 

Quarter-eagle...     "  2.50       58.050      "       "  64.50      "  " 

Dollar Silver  1.00  371.250      "       "  412.50      " 

Half-dollar "  .50        11.250  grams  "  12.50  grams          " 

Quarter-dollar..     "  .25          5625       "       "  6.25 

Dime "  .10          2.250       "        "  2.50      " 


/Copper,  75%\ 
\  Nickel,    25%/ 


Five-cent  piece<N.ckeli'2s%|  0.05       77.160  grains  " 

The  basic  metallic  stock  including  both  coin  and  bullion  of 
the  United  States,  as  of  June  30,  was  as  follows : 

s  All  these  statistical  data  are  taken  from  the  Annual  Reports  of  the  Director  of  the  Mint. 


HISTORY  OP  THE  NATIONAL  COINAGE 


29 


Basic  Metallic  Stock  of  the  United  States 

(In  millions) 


1013 

1914 

1015 

1916 

1917 

1918 

1919 

1920 

Gold 

$1,866 
745 

$1,871 
753 

$1,973 
858 

$2,450 
763 

$3,018 
772 

$3,075 
745 

$3.H2 
568 

$2,708 

548 

Total 

$2,612 

$2,625 

$2,731 

$3,213 

$3.79i 

$3,821 

$3,680 

$3,257 

The  following  table  shows  the  ownership  of  the  gold  stock  and 
the  purposes  which  its  various  parts  are  serving: 

Ownership  of  Gold  and  Silver,  June  30,  1920 

(In  millions) 


Gold  Coin 

and 

Bullion 

Silver  Coin  and  Bullion 

Total  Gold 
and  Silver 

Ownership 

Silver 
Dollars 

Subsidiary 
Coin 

Silver 
Bullion 

Total 
Silver 

Coin  and 
Bullion 

United    States    Treas- 

$    189 

$  14* 

$     6 

$21 

$  42 

$    231 

United    States    Treas- 

ury    (reserved 
against     United 
States     notes     and 

treasury  notes) 

United    States    Treas- 
ury (for  certificates 

Federal  reserve  banks 
(gold  settlement 
fund) 

152 

633 

1,184 
132 

9 
405 

120 
65 
68 

38 
213 

120 
104 
281 

152 

754 
1,184 

National    and    federal 

National    banks     (for 
clearing  house  certi- 

236 
9 

Private  banks  and  in- 

687 

Total  

$3,707 

$268       I        $258 

$31 

$548 

$3,356 

*  Treasury  notes  ar 

e  secured  by  1 

he  dollars 

here  stated 

as  free, 

as  well 

as  by  the  gold 

30 


MONEY,  CREDIT,  AND  BANKING 


The  activity  of  the  Mint  of  the  United  States  is  indicated  by 
the  following  table  which  gives  the  coinage  by  years  and  by  metal : 

Coinage  of  the  Mints  of  the  United  States 

(In  millions) 


Year 

Gold 

Silver 

Minor 

Total 

1910 
1911 
1912 

1913 
1914 

1915 
1916 
1917 
1918 
1919 
1793-1919 

$    104 
56 
17 
25 
53 
24 
18 

3,4io 

$        3 
6 

7 
3 
6 

4 

8 

29 

25 

11 

1,067 

$    3 
3 
2 

4 
2 
2 
6 
6 
6 

9 
100 

$    in 
65 
27 

33 
61 
30 
33 
35 
3i 
20 
4,578 

The  location  of  the  metallic  moneys  of  the  United  States,  as 
of  June  30,  1920,  was  as  follows: 

Location  of  the  Metallic  Moneys  of  the  United  States 

(In  millions) 


In  the 
Treasury 

In   National   and 

Federal  Reserve 

Banks 

In  Other  Banks  and 
in  Circulation 

Total 

$1,794 

21 

376 

134 

6 

$   IS 

116* 
65 
39 

$4«S 

68 

213 

$1,810 

898 

268 

Subsidiary  silver  coin 

258 

Total 

$2,333 

$236 

$687 

$3,236 

*  Includes  $9,814,000  gold  clearing  house  certificates. 


HISTORY  OF  THE  NATIONAL  COINAGE  3 1 

Amount  of  Token  Coinage  Outstanding,  June  30,  1920 

Copper  cents $  1,180,775.36 

Copper  half -cents 39,926.11 

Copper-nickel  cents 1,201,273.36 

Bronze  one-cent  pieces 38,922,741.97 

Bronze  two-cent  pieces 570,007.36 

Nickel  three-cent  pieces 655,423.67 

Nickel  five-cent  pieces 53>498>435-o5 

$96,068,582.88 
Legal  Tender  of  Coins 

Certain  moneys  of  the  United  States  are  "lawful  money." 
This  term  is  used  to  denote  the  legal-tender  quality  of  money,  and 
dates  from  1862. 6  Legal  tender  is  a  quality  given  a  circulating 
medium  by  act  of  Congress.  A  form  of  currency  may  have  such 
attributes  as  to  make  it  generally  acceptable  by  custom  and  yet 
not  possess  the  full  legal-tender  quality.  Congress  by  law  decrees 
that  a  circulating  medium  must,  under  specified  conditions,  be 
accepted  by  creditors  from  debtors  in  liquidation  of  debts  which 
do  not  specify  the  form  of  money  in  which  they  are  to  be  paid. 

Gold  coin  is  legal  tender  at  its  face  value  in  payment  of  all 
debts,  public  and  private,  provided  that  the  coin  is  not  below  the 
standard  weight  and  limit  of  tolerance  prescribed  by  law.  When 
below  such  standard  weight  and  limit  of  tolerance,  gold  coin  is 
legal  tender  in  proportion  to  its  weight.  Any  gold  coin,  if  re- 
duced in  weight  by  natural  abrasion  not  more  than  ]/2  per  cent 
below  the  standard  weight,  after  a  circulation  of  twenty  years  as 
shown  by  its  date  of  coinage,  and  at  a  ratable  proportion  for  any 
period  less  than  twenty  years,  is  received  at  its  nominal  value  by 
the  United  States  Treasury,  but  any  below  this  limit  of  tolerance 
are  to  be  recoined.  Any  holder  of  coin  below  the  limit  is  not  likely 
to  present  it  for  recoinage  if  it  is  possible  to  circulate  it,  for  he  will 
lose  its  deficiency. 

6  Gold  and  silver  certificates  have  not  been  legal  tender  as  between  persons,  but  when 
held  by  national  banks  they  could,  until  1017.  be  counted  as  part  of  their  lawful  reserve 
money.    Gold  certificates  were  made  legal  tender  in  1920. 


32 


MONEY,  CREDIT,  AND  BANKING 


Silver  dollars  are  legal  tender  at  their  face  value  in  payment  of 
all  debts,  public  and  private,  without  regard  to  the  amount,  ex- 
cept where  otherwise  expressly  stipulated  in  the  contract.  Gold 
coins  and  silver  dollars,  being  standard,  are  not  redeemable. 

Subsidiary  silver  coins  are  legal  tender  for  amounts  not  ex- 
ceeding $10  in  any  one  payment.  They  may  be  presented  in 
multiples  of  $20  to  the  Treasurer  of  the  United  States  or  the  fed- 
eral reserve  banks  for  redemption  into  lawful  money. 

Minor  coins  of  nickel  and  bronze  are  legal  tender  to  the  extent 
of  25  cents  in  one  payment,  and  they  are  redeemable  in  multiples 
of  $20,  like  subsidiary  silver. 

United  States  Mints  and  Assay  Offices 

The  place  of  coinage  is  called  the  "mint."  There  are  eleven 
mint  service  institutions  in  the  United  States,  situated  as  follows: 
coinage  mints  at  Philadelphia,  San  Francisco,  and  Denver; 
mints  at  New  Orleans  and  Carson  City  conducted  as  assay  offices; 
an  assay  office  at  New  York,  which  has  a  large  trade  in  bars  of 
fine  gold  and  silver;  and  assay  offices  at  Seattle,  Boise,  Helena, 
Salt  Lake  City,  and  Deadwood,  which  also  function  as  bullion- 
purchasing  agencies  for  the  large  institutions. 

The  relative  size  and  importance  of  the  coinage  mints  are 
indicated  by  the  following  figures  of  the  number  (in  millions)  of 
pieces  coined  in  the  fiscal  year  191 8: 

Pieces  Coined  in  the  Fiscal  Year  1918 

(In  millions) 


Mint 

Silver 

Minor 

Total 

Philadelphia 

$  84.7 
57-9 
43-i 

$380.2 
62.5 
85-5 

$464.9 
120.5 
128.6 

San  Francisco 

Denver 

Total 

5i857 

$518.3 

$714.1 

HISTORY  OF  THE  NATIONAL  COINAGE  33 

No  gold  was  coined  in  the  year  19 18,  the  banner  year  of  the 
mint,  when,  besides  714.1  million  pieces  for  the  domestic  coinage, 
some  52  million  pieces  were  made  for  the  Philippine  and  foreign 
governments.  The  domestic  coinage  for  191 7  was  406.5  million 
pieces,  and  for  191 6  it  was  155  million.  The  value  of  the  coinage 
for  1918  was:  silver,  $35  million;  nickel,  $4.1  million;  bronze,  $4.4 
million;  total,  $43.6  million.  The  seigniorage  on  the  coinage  for 
the  year  amounted  to  $13.2  million  on  the  subsidiary  silver,  and 
$7.2  million  on  the  minor  coins — total,  $20.5  million;  this  con- 
stituted a  very  large  part  of  the  total  income  realized  by  the 
Treasury  from  the  mint  service,  which  was  $22.8  million.  The 
operating  expenses  for  the  year  were  $2.2  million.  To  purchase 
metal  for  the  manufacture  of  minor  coins,  Congress  appropriates 
$200,000  as  the  minor  coinage  metal  fund;  there  is  an  additional 
sum  for  the  alloy  metals. 

Other  Functions  of  the  Mints 

Besides  coinage,  the  mint  institutions  perform  other  functions: 

1.  The  reduction,  until  recently,  of  silver  dollars  to  bullion 

for  shipment  under  the  Pittman  Act. 

2.  The  reduction  and  recoinage  of  gold  and  silver  coins  that 

are  unfit  for  circulation. 

3.  The  making  of  assays  at  nominal  cost  for  the  mining 

industry. 

4.  The  manufacture  of  gold  and  silver  bars  for  shipment. 

In  1918  there  were  made  105,650  bars  of  gold  weighing 
14.8  million  fine  ounces  and  valued  at  $305.9  million, 
and  12,116  silver  bars  weighing  4.5  million  fine  ounces 
and  valued  at  $3.6  million. 

5.  The  receipt  and  determination  of  the  values  and  payment 

for  deposits  of  platinum,  gold,  and  silver  in  the  form  of 
bullion,  plate,  and  jewelry.  These  activities  were  very 
important  during  the  war.  The  platinum  was  refined 
and  made  into  shapes  for  the  use  of  the  government 

V2L.  1—3 


34  MONEY,  CREDIT,  AND  BANKING 

institutions.     Refineries  are  located  at  New  York, 
Denver,  and  San  Francisco. 

6.  The  testing  of  coins  as  to  fineness,  to  see  whether  they 

come  within  legal  requirements. 

7.  The  manufacture  of  dies;  this  is  done  by  the  department 

of  engraving  at  the  Philadelphia  Mint;  in  191 8  it  made 
11,029  dies. 

8.  The  manufacture  of  medals;  14,531  medals  of  gold,  silver, 

and  bronze,  were  made  in  19 18. 

9.  The  Philadelphia  Mint  is  making  a  numismatic  collection, 

by  gift,  purchase,  etc. 

The  United  States  law  (Revised  Statutes,  Section  3547)  pro- 
vides for  an  Assay  Commission  to  examine  and  test  the  weight  of 
the  coins  reserved  at  the  several  mints  during  the  preceding  year. 
This  commission  counts,  weighs,  and  assays,  and  acts  as  a  check 
and  proof  on  the  mint  officials. 


CHAPTER  III 
CREDIT 

Confidence  and  Time  Element 

The  discussion  of  money  has  so  far  dealt  only  with  the  metallic 
forms.  Transactions  in  which  immediate  payment  of  standard 
metallic  money  is  made  are  primarily  barter  transactions — as 
when  one  hat  is  exchanged  for  one  ounce  of  gold;  they  are  trans- 
actions, however,  which  differ  from  the  original  barter  trans- 
actions, inasmuch  as  the  receiver  of  the  gold  does  not  take  it  for 
his  present  industrial  or  personal  use  but  as  a  representative  of 
those  things  for  which  he  is  confident  he  can  exchange  it. 

This  purposed  exchange  may  be  direct  or  indirect.  One  man, 
Brown,  accepts  gold  because  he  is  confident  that  another,  Jones, 
will  take  it  from  him  for  shoes  which  Brown  wishes  and  which 
Jones  has.  This  confidence  is  born  of  custom  and  rests  upon  the 
inertia  of  custom  to  change,  and  is  seldom  if  ever  consciously 
acted  upon.  Brown,  however,  may  accept  silver  or  paper  which 
he  knows  Jones  will  not  accept  for  the  shoes,  but  which  he  knows 
Smith  will  accept  in  exchange  for  gold.  That  is,  Brown  knows 
that  by  indirection  he  can  get  the  shoes  from  Jones.  This  con- 
fidence that  Smith  stands  ready  to  exchange  gold  for  silver  or 
paper  rests  upon  custom,  upon  Smith's  promise,  or  upon  law  or 
public  opinion  compelling  Smith  to  make  such  exchanges. 
Smith's  function  is  to  convert  or  redeem  silver  or  paper  with  gold. 

Thus  the  very  foundation  of  the  money  concept  is  faith  in 
another.  This  faith  is  "credit."  "He  believes."  Brown  believes 
that  Jones  will  accept  and  Smith  will  redeem.  It  is  a  confidence 
which  extends  over  a  period  of  time,  that  is,  Brown  accepts  now, 
believing  that  Jones  or  Smith  will  accept  later.  The  coin  or  paper 
is  the  tangible  evidence  of  that  faith  and  the  measure  of  its 

35 


36  MONEY,  CREDIT,  AND  BANKING 

amount.    A  gold  eagle  or  a  $20  bill  accepted  by  Brown  is  evidence 
that  he  trusts  custom,  promise,  or  law  to  that  amount. 

The  Contract  Element 

Indeed,  Brown  may  desire  the  shoes  but  he  may  not  have 
gold  or  another  commodity  acceptable  to  Jones,  but  Jones,  hav- 
ing confidence  in  Brown's  future  ability  and  willingness  to  provide 
acceptable  commodities,  may  therefore  be  willing  to  transfer  the 
shoes  to  Brown  at  once  and  trust  him  to  transfer  acceptable 
commodities  later.  The  payment,  in  other  words,  is  deferred. 
Since  either  man — or  both — is  likely  to  forget  the  exact  nature 
and  terms  of  this  deferred  payment,  some  written  evidence  is 
usually  prepared  to  describe  it.  This  written  evidence  may  be 
/  simply  a  book  entry,  or  it  may  be  a  special  instrument  drawn  up 
to  which  Brown  subscribes.  In  any  case  the  credit  precedes  and 
exists  independently  of  the  instrument;  contracts,  written  or  parol 
(oral) ,  characterize  a  credit  economy  and  may  well  be  regarded 
an  essential  attribute  of  credits,  but  emphasis  on  this  feature  is 
likely  to  becloud  the  more  fundamental  element — confidence. 

Reduction  of  the  credit  contract  to  writing  serves  several 
purposes,  but  parol  credit  is  just  as  thoroughly  credit  as  is  that 
evidenced  by  written  instruments.  Writing  gives  the  contract 
legal  definiteness;  what  was  possibly  vague,  easily  forgotten,  and 
therefore  subject  to  dispute,  becomes  definite  and  lasting.  If 
left  in  the  form  of  an  entry  in  an  open  book  account,  it  is  still 
subject  to  dispute  by  the  debtor,  and  the  burden  of  proof  of  its 
validity  and  correctness  rests  upon  the  creditor.  But  if  reduced 
to  writing  and  signed  by  the  debtor,  the  law  presumes  that  it  was 
then  and  is  now  valid  and  correct,  hence  the  burden  of  proof  to 
the  contrary  is  upon  the  debtor.  Writing  also  makes  the  contract 
more  easily  transferable.  Writing,  however,  does  not  change  its 
credit  basis;  the  credit  instrument  cannot  be  better  than  the 
credit  which  it  embodies;  its  safety  and  security  do  not  lie  in  the 
form,  but  in  the  credit  conditions  underlying  its  creation;  the 


CREDIT  37 

promissory  note  by  which  a  book  account  is  closed  has  no  greater 
security  than  the  book  account  itself;  it  simply  renders  the  ac- 
count in  a  more  convenient  form  for  the  creditor. 

Jones,  however,  at  the  time  he  grants  credit  to  Brown,  may 
not  know  what  specific  commodities  he  may  want  at  the  maturity 
of  the  credit;  it  serves  his  convenience,  therefore,  to  have  Brown 
promise  to  pay  in  terms  of  the  most  commonly  acceptable  com- 
modity in  the  community,  which  Jones  believes  he  can  exchange 
for  things  then  wanted.  It  is,  therefore,  drawn  in  terms  of  money. 
Money  is  the  standard  of  deferred  payment.  Credit  is  the  de- 
ferred payment.  The  credit  instrument  is  the  certificate  of  such 
deferred  payment.  The  four  attributes  of  credit  are,  therefore, 
standard  money,  confidence,  time,  and  contract. 

Credit  a  Substitute  for  Money 

Credit  serves  the  convenience  of  Brown  and  Jones  in  another 
way.  So  long  as  metallic  money  was  passed  at  the  time  of  ex- 
change, every  exchange  necessitated  the  handling  and  testing  of 
two  commodities — the  article  bought  and  the  gold  given.  The 
gold  had  to  be  carried  to  market,  and  as  exchange  grew  in  fre- 
quency, volume,  and  distance,  to  carry  and  count  metallic  money 
became  bothersome,  dangerous,  and  expensive.  The  receipt  of 
actual  metallic  money  was  no  advantage  except  that  it  might 
be  more  widely  acceptable  than  the  private  credit  of  the 
buyer. 

If,  however,  Jones  accepts  Brown's  credit  and  Brown  accepts 
Jones's  credit,  the  burden  of  actual  money  transactions  can  be 
greatly  reduced.  Promises  may  be  balanced  against  each  other 
and  only  the  net  balances  actually  paid  in  metallic  money.  Credit 
operations,  therefore,  while  making  use  of  standard  money  as  a 
unit  of  account  and  as  a  standard  of  deferred  payment,  obviate 
to  a  large  degree  the  use  of  money  as  a  means  of  payment;  hence 
credit  comes  to  play  an  even  more  important  r61e  than  standard 
money  as  a  circulating  medium.    As  standard  money  facilitates 


38  MONEY,  CREDIT,  AND  BANKING 

exchange  over  the  barter  economy,  so  credit  facilitates  exchange 
over  the  money  economy. 

A  credit  transaction  is  a  form  of  exchange  in  which  credit  is 
given  by  one  of  the  parties;  it  may  be  a  deferred  payment  either 
of  goods  or  of  money,  but  it  is  usually  stated,  for  reasons  shown, 
in  terms  of  the  standard  money;  it  is  a  present  transfer  of  money 
or  economic  goods  or  services  in  consideration  of  a  promise  of  a 
future  return  of  probably  greater  value.  But  it  may  also  be  an 
exchange  of  credit  against  credit,  of  credit  against  a  title  to  goods. 
To  illustrate:  Jones  may  have  a  promissory  note  from  Brown 
which  arose  from  a  deferred  payment  for  shoes,  and  Smith  may 
have  a  similar  note  against  White;  Jones  and  Smith  may  exchange 
these  credits  so  that  Smith  becomes  Brown's  creditor  and  Jones 
becomes  White's.  Such  operations  occur  every  time  a  commercial 
instrument  is  sold  for  government  or  bank  credit  money  and  con- 
stitute the  prime  business  of  the  banks  and  of  the  discount  market. 
In  fact,  credit  transactions  constitute  practically  the  whole  busi- 
ness of  finance  as  now  conducted. 

The  Personal  Element  in  Credit 

It  is  important  to  conceive  the  exact  nature  of  a  credit.  If 
Brown  promises  to  pay  to  Jones  at  some  later  date,  he  creates  a 
property  right;  Jones  thereafter  has  a  claim  on  Brown  and 
Brown's  wealth;  the  state  has  found  it  politically  and  economi- 
cally expedient  to  guarantee,  under  certain  conditions,  this  right; 
it  is  a  "  chose  in  action,"  recoverable  by  law.  Fundamentally  it  is 
a  jus  in  personam— a.  right  against  the  person  of  the  promissor, 
and  once  in  the  history  of  jurisprudence  was  collectible  by  forced 
service  from  him.  Slavery  and  imprisonment  for  debt  have,  how- 
ever, been  abandoned  by  the  civil  state,  and  such  rights,  in  the 
absence  of  wealth  of  the  debtor,  are  rather  moral  claims  against 
him  than  anything  else.  The  importance  of  the  consideration  of 
the  moral  qualities  of  the  debtor  by  the  creditor  is,  therefore,  ap- 
parent; his  ability  to  pay  is  best  indicated  by  his  present  capital 


CREDIT  39 

and  his  earning  capacity,  but  his  willingness  to  pay  depends  upon 
his  character. 

Credit  is  deferred  payment;  the  creditor  has  confidence  in 
the  debtor's  willingness  and  ability  to  pay;  both  willingness  and 
ability  to  pay  rest  upon  personal  as  well  as  impersonal  elements. 
Willingness  to  pay  is  more  a  personal  than  an  impersonal  matter; 
and  ability  to  pay  is  rather  a  matter  of  capital  than  of  character, 
although  the  debtor's  character — his  business  abilities — deter- 
mine in  no  small  degree  his  ownership  or  control  of  capital.  The 
law  supports  the  creditor  as  against  the  debtor  who  is  able  to  pay 
but  will  not;  but  the  law  cannot  make  him  willing  to  pay.  Be- 
cause his  willingness  is  subject  to  caprice,  it  is  difficult  to  estimate 
and  so  limits  his  credit  to  small  compass.  As  business  operations 
and  discounting  become  more  extensive  and  complex,  the  neces- 
sity of  eliminating  or  reducing  the  personal  element  of  credit  or  of 
reinforcing  it  increases,  for  intimate  knowledge  of  the  personal 
character  of  the  debtors  is  more  difficult  to  ascertain. 

Secured  Credit 

The  personal  element  can  be  reduced  by  attaching  to  the  n 
credit  a  concrete  article  of  wealth  or  property  right  which,  having 
assured  and  easily  determined  value,  can  be  readily  sold  and  con- 
verted into  money.  This  insures  ability  to  pay  and  the  law  will 
avail  to  collect  payment.  Such  is  the  method  of  collateral  secu- 
rity. The  promise  in  the  collateral  note  is  backed  by  the  pledged 
wealth  or  property.  Ability  to  pay  can  also  be  practically  as- 
sured by  basing  the  credit  upon  a  strictly  commercial  transaction 
the  completion  of  which  will  put  the  debtor  in  funds  within  the 
period  of  the  debt.  Such  credits  are  said  to  be  "  self-liquidating," 
since  they  assure  the  debtor  of  ability  to  pay,  provided  the  busi- 
ness is  sound.  These  two  methods  may  be  combined  in  one,  the 
collateral  being  commercial  documents  by  which  the  commercial 
transaction  is  effected,  for  example,  bills  of  lading  attached  to  a 
commercial  bill  of  exchange. 


< 


40  MONEY,  CREDIT,  AND  BANKING 

Credit  Indorsement  and  Substitution 

The  personal  element  can  be  reinforced  by  getting,  in  the 
words  of  the  customary  expression,  "someone  to  go  your  secu- 
rity," that  is,  getting  more  "names"  on  the  paper  to  evidence  the 
credit;  the  purpose  of  these  indorsements  is  to  divide  the  risks. 
Synchronous  complete  failures  of  all  the  indorsers  are,  by  the  law 
of  chance,  very  unlikely.  Hence  the  security  of  the  credit  be- 
comes as  strong  as  the  ability,  joint  and  several,  of  the  indorsers 
to  pay,  but  no  stronger. 

The  personal  element  can  also  be  reinforced  by  getting  some 
party  who  is  better  known,  stronger  in  wealth  and  connection, 
and  with  good  financial  record,  to  substitute  as  debtor.  The  prac- 
tice of  issuing  and  using  letters  of  credit  is  based  upon  this  idea. 
A  New  York  bank  makes  arrangements  with  an  English  bank 
whereby  the  latter  agrees  to  accept  bills  drawn  on  it  by  a  Brazil- 
ian exporter;  otherwise  the  New  York  importer  would  have  to  be 
drawn  on  and  the  Brazilian  could  get  from  the  Rio  de  Janeiro  bank 
but  a  very  low  price  for  the  bill  as  compared  with  one  drawn  on 
the  English  bank.  This  substitution  of  debtor  constitutes  the 
fundamental  difference  between  the  bank  acceptance  and  the 
trade  acceptance. 

Commercial  and  Financial  Credits 

Credit  is  deferred  payment;  there  is  a  period  of  trust,  and  it 
may  be  long  or  short.  The  longer  the  period  the  more  the  con- 
tingencies against  which  the  creditor  must  provide.  "Com- 
mercial credits"  have  come  to  differentiate  themselves  from  "fi- 
nancial credits"  on  the  basis  of  the  term;  the  former  are  for  10,  20, 
30,  60,  90,  and  120  days,  and  are  evidenced  by  promissory  notes, 
checks,  drafts,  bills  of  exchange,  acceptances,  and  so  forth;  the 
latter  are  for  periods  of  1,  2,  3,  5,  10,  20,  and  40  years,  and  are 
evidenced  by  various  forms  of  notes,  bonds,  and  certificates. 
Commercial  or  mercantile  credits  are  used  to  conduct  the  daily 
operations  of  business  life.    It  is  always  assumed  that  the  money 


CREDIT  41 

or  goods  are  to  be  used  in  such  ways  that  the  debtor  will  be  in  a 
position  to  realize  upon  his  transaction  within  the  period  of  the 
credit  and  so  will  be  able  to  pay  upon  maturity. 

Financial  credits,  on  the  other  hand,  being  for  long  terms  of 
years,  are  issued  with  the  idea  that  the  money  or  wealth  which  the 
creditor  contributes  to  the  debtor  is  for  quite  permanent  use.  If 
the  creditor  wishes  to  regain  his  funds  before  maturity  he  does  so 
by  selling  the  credit  instrument  to  another  who  may  wish  to  be- 
come creditor  to  the  debtor;  and  it  is  commonly  understood  that 
the  debtor  will  never  make  repayment  in  his  own  money  or  goods, 
but  that  the  present  credit  will  be  met  at  maturity  by  refunding, 
that  is,  borrowing  further  funds  either  from  the  same  creditor  or 
others.  There  are,  however,  various  practices  by  which  com- 
mercial credits  function  in  real  fact  as  long-term  credits. 

Definition  of  Commercial  Credit 

Exact  agreement  does  not  exist  among  financial  men  and 
writers  as  to  the  definition  of  commercial  credits.  In  the  United 
States  the  term  "commercial  paper"  is  widely  used  in  a  very 
technical  sense,  and  refers  only  to  such  paper  as  is  marketed 
through  note-brokers.  Such  paper  is  short  term,  but  is  in  large 
part  continually  renewed  at  maturity  and  sold  to  present  holders 
or  others,  and  therefore  represents  long-term  advances.  Another 
restrictive  definition  makes  commercial  credit  relate  only  to  credit 
extensions  which  facilitate  the  marketing  of  products.  This 
definition  is  too  restrictive;  industrial  loans  for  the  purpose  of 
buying  raw  materials  and  paying  wages  to  workers  may  be  as 
self-liquidating,  may  be  for  as  short  terms,  and  as  safe  for  tempor- 
ary investment  as  mercantile  loans.  This  definition  would  ex- 
clude also  loans  to  speculators  and  brokers,  a  considerable  part  of 
which  are  characterized  by  the  two  essentials  of  commercial 
credit,  namely,  short  term,  and  self-liquidation.  Important  dif- 
ferences of  opinion  as  to  banking  policy  often  arise  from  the  in- 
ability to  agree  on  a  strict  definition  of  commercial  credit. 


42  MONEY,  CREDIT,  AND  BANKING 

Effect  of  Time  Element  on  Credit  Values 

The  time  element  in  a  credit  ordinarily  gives  rise  to  discount 
when  the  credit  is  exchanged  against  money.  If  a  promissory 
note  does  not  mature  till  30  days  hence,  the  holder  cannot  hope 
to  find  in  the  business  world  a  purchaser  who  will  pay  down  at 
once  its  face  value  for  it,  since  such  a  purchaser  would  be  de- 
prived of  the  use  of  the  purchase  price  for  30  days;  for  this  reason 
a  purchaser  would  deduct  the  interest  in  advance  and  pay  the 
proceeds.  In  practice  this  is  calculated  either  as  true  or  as  bank 
discount,  depending  upon  the  purchaser.  Long-term  instru- 
ments, such  as  bonds,  are  invariably  valued  by  true  discount. 

The  time  element,  however,  is  ordinarily  ignored  in  case  of 
credit  instruments  payable  upon  demand  and  about  which  there 
is  no  doubt  as  to  the  willingness  and  ability  of  the  debtor  to  pay. 
Promises  of  the  government  to  pay  on  demand,  and  similar  prom- 
ises of  reputable  banks,  are  accepted  without  discount  because 
these  promises  will  themselves  function  as  a  medium  of  exchange, 
and  the  person  who  accepts  them  in  exchange  for  a  credit  instru- 
ment, goods,  or  services  will  not  lose  the  use  of  the  funds  during 
the  time  until  the  promissory  notes  can  be  redeemed.  These  pro- 
mises can  be  used  immediately  and  without  discrimination  or  dis- 
count. They  circulate  as  money  themselves .  To  give  such  demand 
instruments  is  one  method  of  paying,  whereas  to  give  a  time  instru- 
ment that  is  subject  to  discount  is  not,  in  common  parlance, "  pay- 
ing' ' ;  one  does  not  pay  by  giving  his  note.  The  commonest  forms 
of  demand  instruments  that  circulate  as  money,  and  are  money,  are 
government  notes  and  bank  notes,  and  also  bank  deposits  but  for 
their  limited  acceptability  attain  to  the  r61e  of  money. 

Other  Kinds  of  Credit 

Another  form  of  credit  is  commonly  called  "personal,"  or 
"consumptive,"  credit,  on  the  theory  that  such  credits  "spend 
themselves  in  the  consumption  or  annihilation  of  necessities  and 
articles  of  luxury  as  opposed  to  those  utilities  of  credit  which  as- 


CREDIT  43 

sume  a  productive  or  distributive  character."  This  kind  of  credit 
was  the  earliest  historically,  and  gave  birth  to  our  credit  system 
by  educating  men  in  the  honest  keeping  of  contracts;  but  personal 
credit  constitutes  a  relatively  small  fraction  of  present-day  credits 
and  is  discouraged  by  credit-givers. 

Still  another  form  of  credit  may  be  specified  in  this  classifica- 
tion on  the  basis  of  uses  to  which  the  funds  are  devoted.  It  is 
"public"  credit.  The  debtor  is  the  body  politic,  and  the  funds 
raised  are  diverted  to  the  uses  of  the  state.  Such  credits  are 
usually  long  term  and,  being  strictly  financial  credits,  partake  of 
the  qualities  of  the  bonded  debt  of  corporations. 

Relation  of  Credits  to  Wealth 

The  credit  instruments  are  many  and,  to  facilitate  their  va- 
rious uses,  are  highly  specialized.  Book  credits,  promissory  notes, 
bills  of  exchange,  drafts,  acceptances,  certificates  of  indebtedness, 
checks,  bank  notes,  bonds,  and  the  like  all  arise  from  credit 
transactions,  however  much  the  instruments  themselves  may 
differ  in  their  details  of  form  and  terms,  in  their  power  to  circu- 
late, and  in  their  creation  by  debtor  or  creditor.  They  purport 
to  be  claims  for  money,  are  evidences  of  debt  of  the  debtor  and  of 
credit  by  the  creditor,  and  are  used  to  facilitate  the  exchange  of 
goods  and  the  investment  of  funds. 

The  issue  of  credit  does  not,  however,  by  itself  directly 
increase  the  wealth  of  the  community.  If  Brown  gives  Jones  a 
promissory  note  the  volume  of  credit  in  the  community  has  been 
increased  by  that  amount,  but  the  volume  of  wealth  has  not  been 
affected  one  iota  by  that  act.  The  deferment  of  the  payment 
may,  however,  leave  the  capital  in  Brown's  hands,  and  Brown 
may  be  a  more  efficient  producer  of  wealth  than  Jones;  the  net 
result  of  the  credit  transaction  for  the  community  will  thus  in- 
directly be  an  increase  of  wealth. 

The  presumption  is  that  the  borrower  is  a  more  efficient  pro- 
ducer than  the  lender,  else  the  lender  would  use  the  capital  in  his 


44  MONEY,  CREDIT,  AND  BANKING 

own  productive  activities.  One  of  the  greatest  functions  of 
credit  is  just  this — it  throws  control  of  productive  capital  into 
the  hands  of  the  most  efficient  producers,  and  this  control  results 
in  additional  consumable  commodities  for  the  community.  One 
of  the  commonest  of  errors  is  to  fail  to  keep  in  mind  the  funda- 
mental fact  that  credits  are  not  wealth,  but  at  best  claims  to 
wealth,  and  that  their  issue  does  not  add  directly  to  the  wealth  of 
the  community.  The  issue,  for  instance,  of  multiplied  millions 
of  dollars  of  credits  by  the  government  does  not  increase  our  na- 
tional wealth  directly,  however  prone  the  owner  of  a  dollar  bill  is 
to  regard  it  as  part  of  his  wealth. 

Fundamental  Basis  of  Credit 

A  credit  rests  upon  the  person  or  wealth  of  the  debtor;  even 
when  apparently  based  upon  credits  the  ultimate  basis  is  concrete  V 
wealth.  For  instance,  a  mortgage  company  may  pledge  mortgages 
and  mortgage  notes  as  security  for  debenture  bonds  issued  by  them) 
and  sold  to  the  public;  the  holder  of  such  a  debenture  bond  ma/ 
pledge  it  with  his  bank  to  secure  an  advance  to  his  account;  then 
the  holder  of  a  check  drawn  by  this  bank  customer  has  a  credit  in- 
strument which,  in  its  ultimate  analysis,  is  a  property  right  in  the 
mortgaged  land. 

This  illustration  shows  how  very  useful  credit  is  in  making 
fixed  wealth  rapidly  transferable  and  marketable  so  that  it  may 
be  diverted  to  that  operator  who  can  make  best  use  of  it.  The 
land  remains  intact  and  the  operator  is  able,  by  the  issue  of  credit 
based  upon  it,  to  procure  seed,  machinery,  fertilizer,  and  the  like, 
with  which  to  work  the  land.  Persons  in  other  parts  of  the  coun- 
try who  have  funds — titles  of  purchasing  power — are  willing  to 
exchange  these  funds  for  credits  based  upon  land 

Relation  of  Credits  to  Interest 

It  is  human  nature  to  prefer  present  economic  goods  or  ser- 
vices to  future  economic  goods  or  services,  the  degree  of  prefer- 


CREDIT  45 

ence  varying  with  the  person — with  his  personal  characteristics 
and  the  nature  of  his  income.  If  Brown  is  less  impatient  for  in- 
come than  Jones,  he  will  lend  to  the  latter,  but  if  more  impatient, 
he  will  borrow;  borrowing  tends  to  lower  the  impatience  of  the 
borrower  and  raise  it  for  the  lender.  Given  a  market  of  borrowers 
and  lenders  there  will  result  a  market  rate  about  which  borrowing 
and  lending  will  crystallize.  This  rate  measures  the  general  no- 
tion as  to  how  much,  in  a  certain  community  at  a  certain  time, 
present  goods  are  preferred  to  future  goods;  it  denotes,  in  other 
words,  that  lenders  are  willing  to  lend  $100  today  for  $105  repaid 
one  year  later;  the  premium,  5  per  cent,  is  our  market  rate  of 
interest.  Whenever  a  credit  is  drawn,  this  element  of  time  pref- 
erence enters,  and  the  value  of  the  goods  or  the  money  returned 
at  maturity  must  exceed  the  value  of  the  goods  or  money  origi- 
nally paid.  A  borrower  is  willing  to  pay  this  premium  for  the  use 
of  goods,  or  for  money  which  represents  goods,  for  various  rea- 
sons, but  in  any  case  the  borrower  must  be  satisfied  that  the  goods 
are  worth  more  to  him  (at  the  market  rate  of  interest)  than  to  the 
lender.  One  of  these  reasons  would  be  that  he  feels  himself  by  the 
amount  of  the  interest  a  more  efficient  producer  than  the  lender. 

Credits  as  Circulating  Media 

In  its  function  of  facilitating  exchange,  credit  may  become  the 
actual  medium.  An  earnest  of  this  was  seen  in  the  treatment  of 
subsidiary,  fiduciary,  or  token,  coins.  A  credit  medium  is  more 
economical  than  a  metallic  medium.  The  expenditure  of  labor 
and  capital  in  producing  metals  for  monetary  use  is  a  big  item  of 
expense  for  society.  Moreover,  these  metals  have  industrial  uses 
— and  the  erection  of  a  superstructure  of  credit  on  a  reserve  of 
metallic  money  conserves  the  metal  for  use  in  the  arts.  Since  the 
creation  of  a  credit  currency  is  done  with  less  effort  than  that  of  a 
metallic  currency,  there  is  an  economic  advantage  in  substituting 
credit  for  metallic  media  wherever  possible.  Such  substitution, 
though  not  without  danger,  is  within  limits  highly  beneficial. 


46  MONEY,  CREDIT,  AND  BANKING 

Any  medium  circulates  for  one  or  more  fundamental  reasons. 
Certain  counters  may  circulate  by  express  or  implicit  agreement 
among  a  limited  group,  as  gamblers'  poker  chips.  It  has  been 
shown  that  commodity  money  attains  and  maintains  this  func- 
tion because  of  a  belief  in  the  stability  and  the  persistence  of  social 
custom.  Credit  rests  upon  confidence  in  the  issuer.  The  issuer 
may  be  a  government,  a  corporation,  a  firm,  or  an  individual ;  in 
any  case  the  credit  issued  will  have  a  more  or  less  extensive  circu- 
lation, dependent  upon  the  public's  opinion  of  the  ability  and 
willingness  of  the  issuer  to  meet  his  promises.  Credit  may  be 
classified,  therefore,  on  the  basis  of  whether  or  not  it  has  general 
acceptability.  Those  forms  of  credit  which  do  possess  general 
acceptability  perform  all  the  functions  of  money,  and  usually 
more  efficiently  than  money. 

Media  which  have  only  a  restricted  circulation  are: 

i.  Securities  (stocks  and  bonds).  These  are  usually  too 
highly  specialized,  too  technical,  too  dependent  upon 
market  conditions,  and  too  large  in  denomination  to 
acquire  a  general  circulation.  They  are,  however,  quite 
commonly  used  in  making  large  payments  at  great 
distances,  as  overseas.  Where  the  expense  of  shipping 
gold  runs  high,  securities  of  international  reputation 
may  be  used  to  settle  credit  balances. 

2.  Credit  instruments,  like  checks,  drafts,  promissory  notes, 
acceptances,  and  the  like,  which  have  only  a  local  cir- 
culation among  a  limited  circle  who  know  the  issuer, 
drawee,  drawer,  or  acceptor. 

Credit  media  which  have  a  general  circulation  are: 

i .  Government  issues : 

(a)  Convertible  metallic  money,  as  nickels  and  coppers. 

(b)  Certificates  of  deposit  of  metallic  money. 

(c)  Convertible  paper  money. 

(d)  Inconvertible  paper  money. 


CREDIT  47 


2.  Bank  issues:1 

(a)  Deposits,  represented  by  checks. 

(b)  Bank  notes. 


1  The  relative  degree  to  which  deposits  and  bank  notes  enjoy  a  general  circulation  will  be 
treated  in  Chapter  V. 


CHAPTER  IV 
GOVERNMENT   PAPER   OR   CREDIT   MONEY 

Wide  Acceptability  of  Government  Credit 

From  the  creditor's  point  of  view,  credit  represents  the  trust 
he  has  in  the  debtor;  from  the  debtor's  point  of  view,  credit  is 
borrowing  power,  the  power  he  has  to  induce  the  creditor  to  put 
economic  goods  at  his  disposal  for  a  period  of  time,  on  the  prom- 
ise of  repayment  at  maturity.  The  power  of  the  borrower  coin- 
cides in  all  respects  with  the  trust  of  the  creditor,  the  one  being 
but  an  opposite  aspect  of  the  other. 

A  government  enjoys  higher  borrowing  power  than  other 
borrowers.  The  war  loans  of  1914-1919,  towering  into  scores  of 
billions,  exceeded  all  previous  credit  operations.  Such  credits 
indeed  were  quite  beyond  the  estimates  of  the  most  sanguine 
financier  before  19 14;  the  way  the  people  of  the  belligerent  coun- 
tries have  loaned  to  their  governments  is  amazing.  Nevertheless 
there  are  limits  to  a  government's  credit,  however  elastic  they 
may  seem  under  the  spur  of  patriotism,  efficient  publicity,  and 
appeal,  and  practically  every  existing  government  has  at  some 
time  experienced  a  want  of  unhesitating  financial  support. 

The  emphasis  here  is  on  the  breadth  of  government  credit. 
People  visualize  the  state  only  dimly  and  consequently  are  prone 
to  feel  it  is  quite  omnipotent.  Since  it  draws  its  powers  from  the 
people  and  is  held  to  be  as  just  as  their  ideals,  it  is  believed  to  be 
not  only  able  but  also  willing  to  keep  its  promises.  It  takes  a 
catastrophe  to  shake  this  confidence.  Credit  instruments  of  the 
state,  in  small  round  denominations  and  payable  on  demand,  are, 
because  of  this  high  confidence  in  the  government,  most  likely  to 
be  freely  accepted  by  any  citizen  of  the  country  and  to  pass  read- 
ily from  person  to  person  at  par,  rousing  scarcely  a  thought  of 

48 


GOVERNMENT  PAPER  OR  CREDIT  MONEY  49 

having  them  redeemed  in  metallic  money.  One  man  buys  goods 
from  another,  but  instead  of  paying  standard  money,  or  giving 
his  note,  or  having  the  debt  charged  on  a  book  account,  may  pay 
with  a  note  issued  by  the  government,  which  note  has  come  into 
his  hands  by  some  previous  business  transaction.  That  is  to  say, 
the  first  man  was  for  a  time  the  creditor  of  his  government  and 
now  the  second  man  becomes  creditor.  This  ready  shift  in  the 
ownership  of  a  government  note  and  in  the  personnel  of  the  cred- 
itor constitutes  its  circulation.  So  long  as  the  government  note 
circulates  freely  it  performs  all  the  functions  of  money  and  is 
popularly  and  rightly  understood  to  be  money. 

Classification  of  Government  Credit  Money 

Government  paper  money  is  of  three  sorts,  the  classification 
being  based  on  the  proportionate  reserve  of  standard  money 
which  the  Treasury  keeps  on  hand  to  redeem  credit  money,  and 
to  instil  into  the  people's  mind  the  government's  intent  and 
ability  to  redeem  on  demand.  The  longer  the  credit  money 
stays  in  circulation,  that  is,  the  fewer  the  presentations  for  re- 
demptions, the  smaller  may  this  reserve  be;  but  the  very  size  of 
this  reserve  may  be  a  deciding  factor  in  delaying  such  presenta- 
tions. 

Certificates.  The  first  class  of  government  paper  has  full  face 
value  in  standard  money  in  reserve.  The  silver  dollar  by  reason 
of  its  size  and  weight  is  awkward  and  burdensome  for  commercial 
uses;  except  in  limited  areas  of  the  country  which  have  become 
thoroughly  habituated  to  its  use,  it  will  not  circulate,  but  drifts 
at  once  to  bank  reserves  and  the  government  Treasury.  Nor  is 
its  circulation  desirable,  for  the  losses  from  erosion  are  heavy. 
A  simple  device  used  by  the  government  to  obviate  these  difficul- 
ties is  to  give  to  any  depositor  of  silver  dollars  or  silver  bullion  cer- 
tificates of  deposit  certifying  that  the  government  holds  on  hand 
face  value  of  silver  which  is  payable  upon  demand. 

As  only  a  few  of  the  certificates  will  be  presented  for  re- 

VOL.  I — 4 


50  MONEY,  CREDIT,  AND  BANKING 

demption,  it  is  not  necessary  that  much  of  the  silver  be 
coined. 

Certificates  are  really  warehouse  receipts  and,  like  any  re- 
ceipt of  this  kind,  their  value  takes  into  consideration  the  char- 
acter of  the  warehouseman  and  his  warehouse.  Because  the 
government  and  the  Treasury  stand  in  such  high  esteem,  cur- 
rency certificates  are  accepted  generally  and  without  equivoca- 
tion, but  that  this  form  of  paper  money  does  not  add  to  the  total 
of  existing  currency  is  nevertheless  evident. 

Convertible  Paper.  The  second  class  of  paper  money  has  a 
fraction  of  its  face  value  held  in  reserve  in  standard  money,  to 
meet  demands  for  redemption.  It  is  spoken  of  as  "convertible," 
that  is,  the  Treasury  stands  ready  to  redeem  it  at  any  time. 
As  long  as  this  convertible  money  is  faithfully  and  freely  re- 
deemed, the  promises  are  worth  their  face  value;  any  distrust, 
however,  results  in  a  run  on  the  Treasury,  which,  if  great  and 
long  continued,  may  exhaust  the  reserve  fund.  The  government 
may  also  suffer  reverses  in  revenue  receipts,  or  expenditures  may 
be  extraordinary,  and  its  ability  to  carry  on  conversion  may  be 
impaired.  While  a  reserve  of  ioo  per  cent  is  at  no  time  necessary, 
since  there  is  no  probability  of  a  simultaneous  demand  on  the  part 
of  all  holders,  it  is  nevertheless  expedient  to  keep  a  considerable 
reserve;  one  of  the  best  evidences  of  the  intention  and  ability  of 
the  government  to  fulfil  its  promises  to  redeem  is  the  creation  and 
maintenance  of  a  special  fund  for  this  purpose.  The  fund  should 
be  separate  from  the  general  funds  of  the  Treasury  and  be  used 
exclusively  for  redemption  purposes;  the  size  of  the  fund  must 
vary  with  the  probability  of  the  demand  for  conversion,  which 
must  be  determined  from  experience  and  from  the  contingencies 
of  the  government  credit. 

It  is  also  important  to  note  that  ultimate  redeemability  is  not 
equivalent  to  immediate  convertibility.  If  the  paper  is  immedi- 
ately convertible  it  stays  at  par,  but  if  redeemable  only  after  a 
period  of  indefinite  length  it  will  be  regarded  as  an  investment  or 


GOVERNMENT  PAPER  OR  CREDIT  MONEY  5 1 

as  a  deferred  payment,  and  its  present  value  will  differ  from  its 
face  value  by  discount  for  interest  and  risk.  In  this  case  it  does 
not  matter  whether  the  issuing  government  is  rich  in  natural 
resources;  it  is  the  present  means  of  payment  that  maintains  the 
parity. 

The  reserve  held  may  be  determined  in  several  ways,  such  as 
the  following:  It  may  be  a  minimum  percentage  required,  the 
issue  and  the  reserve  bearing  a  predetermined  minimum  ratio; 
or  it  may  be  a  certain  fixed  minimum  quantity  of  specie  whose 
ratio  to  the  issue  would  vary  inversely  with  the  amount  of  issue; 
or  the  reserve  may  consist  of  securities  and  gold,  the  law  fixing 
the  maximum  amount  of  the  "uncovered"  issue  (the  notes 
backed  by  the  pledged  securities)  and  requiring  the  excess  above 
that  amount  to  be  "  covered  "  by  ioo  per  cent  of  gold. 

Inconvertible  Paper.  The  third  class  of  government  paper  money 
is  variously  called  "fiat"  money,  "political"  money,  and  "in- 
convertible" paper  money.  This  kind  usually  results  from  exces- 
sive issues  of  convertible  paper  money  so  large  that  the  citizens 
doubt  the  government's  ability  or  intention  to  redeem  on  de- 
mand, a  doubt  which  is  later  justified  by  an  actual  suspension  of 
specie  payments.  These  inconvertible  bills  are  promises  of  the 
government  to  pay  on  demand,  though  at  the  time  of  issue  the 
government  may  have  no  intention  of  keeping  its  promise. 
Sometimes  they  are  issued  as  orders  on  the  Treasury  to  pay  upon 
demand,  the  government  well  knowing  the  Treasury's  inability 
to  meet  such  demands;  and  sometimes  they  are  simply  printed 
statements  proclaiming  the  bills  to  be  the  equivalent  of  such  and 
such  amounts  of  metallic  money. 

Value  of  Inconvertible  Money 

To  give  acceptability  to  inconvertible  paper,  the  government 
usually  makes  special  provisions.  One  is  to  declare  it  legal  tender 
in  payment  of  private  and  public  dues.  Unless  the  people  unite  to 
boycott  the  use  of  inconvertible  money,  the  government's  legal 


52  MONEY,  CREDIT,  AND  BANKING 

sanction  can  force  its  receipt  at  par  for  debts,  with  the  result  that 
its  acceptability  for  other  purposes  will  follow.  Of  course,  the 
existence  of  inconvertible  money  does  not  prevent  a  creditor 
from  contracting  in  terms  of  gold,  nor  does  it  prevent  his  asking  a 
higher  sum  in  payment,  if  the  contract  be  drawn  in  terms  of 
general  money.  Its  depreciation  may,  therefore,  persist  despite 
legal-tender  laws. 

The  extent  to  which  the  paper  declared  is  legal  tender  may, 
however,  be  limited  to  the  payment  of  taxes  and  debts  to  the 
government.  If  issued  in  anticipation  of  taxes  soon  to  be  levied 
and  in  amounts  equal  to  those  taxes,  it  will  likely  keep  at  par,  for 
the  people  accepting  it  will  really  be  paying  their  taxes  in  advance, 
and  when  the  taxes  come  due  they  will  not  care  whether  they  pay 
in  standard  or  in  inconvertible  money.  Such  issues  will  not  be 
excessive;  the  tax  levy  will  act  as  governor  of  the  issue,  and  loss  of 
faith  in  the  issue  is,  therefore,  unlikely.  If,  however,  issues  ex- 
ceed taxes,  laid  or  to  be  laid,  the  volume  of  circulation  will  be 
inflated  by  the  excess. 

The  above  methods  of  promoting  acceptability  and  maintain- 
ing parity  are  unavailing  if  the  issues  become  excessive.  The 
volume  issued  may  be  so  large  as  to  discredit  the  government's 
ability  or  intention  to  redeem,  and  far  exceed  its  capacity  to 
absorb  by  way  of  taxes.  Depreciation  then  becomes  inevitable. 
After  the  public  has  become  used  to  convertible  paper  a  certain 
volume  that  is  inconvertible  will  by  force  of  habit  circulate  with- 
out question.  If  the  issue  thereafter  is  limited  to  the  growing 
needs  of  business  at  the  existing  price  level,  there  will  be  no  depre- 
ciation; greater  issues,  however,  will  result  in  depreciated  values 
in  terms  of  gold  inversely  proportional  to  the  volume.  The  most 
effectual  method  of  maintaining  the  value  of  inconvertible  money 
is,  therefore,  to  limit  its  issue.  There  is  no  way  of  determining  in 
advance  the  amount  which  a  country  may  issue  and  keep  at  par; 
the  risk  is  psychological,  varying  with  the  people,  time,  and  con- 
ditions.   In  times  of  peace,  normal  order,  and  ready  collection  of 


GOVERNMENT  PAPER  OR  CREDIT  MONEY  53 

taxes,  a  much  larger  sum  of  credit  can  be  supported  than  in  times 
of  panic,  war,  or  falling  tax  receipts. 

Danger  of  Overissue  of  Government  Paper  Money 

The  danger  or  likelihood  of  overissue  is  the  greatest  objection 
to  government  paper  money.  Overissue  brings  about  inflation, 
rising  prices,  bigger  profits,  business  boom,  and  a  demand  for 
more  and  more  issues;  the  cycle  once  begun  is  intoxicating  and  in 
democracies  the  legislatures  are  likely  to  yield  to  the  popular 
clamor  for  new  issues.  Every  issue,  however,  means  an  inflation 
of  prices,  a  scaling  of  debts  and  contracts.  The  train  of  attendant 
evils  is  dire,  and  ultimate  catastrophe  is  inevitable.  Credit  thus 
defeats  itself.  Moreover,  a  paper  money  party  invariably  arises 
which  preaches  the  doctrine  that  paper  money,  being  cheap  and 
easily  created  and  performing  the  functions  of  money  satisfactor- 
ily, is  the  best  kind  of  money,  and  a  better  means  of  finance  indeed 
than  taxes — which  directly  affect  pocketbooks — or  than  bond 
sales — which  must  later  be  repaid  with  interest.  Paper  issues 
work  out  their  results  so  insidiously  and  indirectly  through  infla- 
tion that  for  a  time  only  their  virtues  are  perceived,  while  their 
evils  work  unhindered. 

The  issuing  government  is  not  without  guides  to  determine 
when  an  issue  is  excessive.  One  indication  is  a  premium  on  gold; 
paper  will  be  accepted  only  at  a  discount,  the  premium  varying 
with  the  issues  and  with  the  government  credit.  Since  foreign 
payments  must  be  settled  in  gold,  foreign  exchange  rates  in  a 
paper  money  country  will  rise  and  fall  as  the  price  of  gold  in  terms 
of  paper  fluctuates.  Metallic  money,  first  the  standard  money 
and  then  subsidiary  forms,  will  be  withdrawn  from  circulation  and 
go  into  hiding,  into  the  melting  pot,  or  abroad.  Prices  payable  in 
paper  will  rise  largely  and  rapidly,  but  a  holder  of  specie  can  really 
buy  on  approximately  the  old  basis  by  exchanging  his  gold  for 
paper  and  buying  at  the  paper  prices.  The  premium  on  gold  is 
thus  a  rough  index  to  the  appreciation  of  prices  of  goods. 


54  MONEY,  CREDIT,  AND  BANKING 

Advantages  and  Disadvantages  of  Paper  Money 

The  advantages  of  the  issue  of  government  paper  money  are : 
i.  It  is  economical,  since  it  substitutes  a  less  expensive  ma- 
terial than  metal  for  money  and  conserves  the  metal  for  the  arts. 

2.  It  is  easily  and  quickly  increased;  the  printing  press  is  more 
expeditious  than  the  mine,  smelter,  and  mint. 

3.  It  has  fiscal  advantages;  in  emergencies,  before  taxes  can 
be  laid  or  bonds  sold,  paper  money  may  be  run  off  in  anticipation 
of  taxes  or  receipts  from  sales  of  bonds ;  it  can  be  used  to  pay  the  ob- 
ligations of  the  state,  and  amounts  to  a  forced  loan  without  interest . 

4.  It  is  more  convenient  than  metallic  money;  it  is  light  in 
weight  and  the  weight  does  not  increase  with  the  amount;  it  is 
easy  to  conceal  and  to  ship  by  mail  or  express. 

5.  If  properly  issued,  it  provides  a  certain  elasticity  to  the 
currency. 

Paper  money  has  also  many  disadvantages  and  attendant  evils : 

1 .  The  greatest  has  been  pointed  out — the  high  probability  of 
overissue,  with  consequent  disturbance  of  contracts,  business 
morale  and  relationships,  and  foreign  exchanges. 

2.  The  government  may  also  suffer;  it  is  a  heavy  purchaser, 
especially  at  such  times  as  free  resort  is  likely  to  be  made  to 
inconvertible  issues,  and  it  pays,  like  individuals,  the  higher  prices 
due  to  inflation;  the  government  expenditures  are  increased  and 
the  purchasing  power  of  its  receipts  decreased,  and  as  a  net  result 
the  public  debt  is  expanded. 

3.  The  area  of  circulation  of  paper  money  is  very  limited; 
gold  will  be  accepted  internationally  but  paper  only  in  the  coun- 
try issuing  it;  it  cannot  be  used  in  international  settlements.  Its 
value,  therefore,  depends  on  the  accidents  of  a  limited  area,  and 
is  more  subject  to  fluctuation  than  that  of  gold,  which  is  steadied 
by  the  equalizing  tendencies  of  parts  of  a  broad  area. 

4.  Paper  money  has  less  stability  of  value,  also,  for  the  reason 
that  it  has  only  one  use,  namely,  its  monetary  use.  The  metals, 
on  the  other  hand  have  an  equal  or  greater  use  in  the  arts,  for 


GOVERNMENT  PAPER  OR  CREDIT  MONEY  55 

which  the  demand  is  relatively  constant,  inasmuch  as  social 
usages  change  slowly  and  the  demand  for  silver  or  gold  utensils 
shifts  but  little.  The  total  demand  for  the  metal  is,  therefore, 
on  a  wider  basis  than  the  demand  for  paper  money,  and  its  value 
is  thereby  stabilized. 

Government  Paper  Money  Issued  by  the  United  States 

The  issues  of  paper  money  of  the  United  States  government 
now  current  for  which  the  government  is  direct  debtor  embrace 
the  United  States  notes,  the  treasury  notes  of  1890,  the  gold  and 
silver  certificates,  the  gold  order  certificates,  and  the  federal 
reserve  notes.  Our  history  is  replete  with  experiments  in  govern- 
ment money.  The  colonies  issued  such  money  to  finance  wars  or 
the  ordinary  expenses  of  government,  and  to  make  loans  to  in- 
dividuals. The  various  colonial  issues  differed  in  the  degrees  to 
which  they  were  made  legal  tender  and  bore  interest;  but  over- 
issue characterized  practically  every  lot.  During  the  Revolution 
the  "continentals"  were  used  to  finance  the  war,  and  excessive 
issues  so  depreciated  their  value  that  they  became  worthless. 
In  the  period  1812-1815  successive  issues  of  legal  tenders  were 
made,  with  the  result  that  specie  payments  were  suspended  and 
gold  commanded  a  premium.  Later  issues  were  made  during  the 
distress  following  the  panic  of  1837,  which  extended  over  the  years 
183  7-1842,  and  in  connection  with  the  financing  of  the  Mexican 
War,  and  again  after  the  panic  of  1857.  These  issues  were  in 
moderate  amounts  and  were  not  objectionable.  During  the  Civil 
War,  however,  the  real  disaster  came  with  the  issue  of  United 
States  notes,  popularly  called  "legal  tenders,"  or  "greenbacks." 
The  Confederacy  also,  as  well  as  many  of  the  Confederate  States, 
issued  overwhelming  quantities  of  notes. 

Greenbacks 

The  greenback  issues  were  started  in  1861  and  continued 
throughout  the  war.  The  government  suspended  specie  payments 


56  MONEY,  CREDIT,  AND  BANKING 

in  1862  and  the  greenbacks  depreciated  until,  in  1864,  they 
brought  less  than  40  cents  on  the  dollar  in  gold.  The  fluctuations 
in  value  were  wide  and  frequent,  varying  with  the  fortunes  of 
war  and  the  markets. 

Contraction  was  undertaken  at  the  conclusion  of  the  war,  but 
abandoned  in  1868.  In  1879  specie  payments,  according  to  the 
pledge  of  the  Specie  Resumption  Act  of  1875,  were  resumed,  the 
Secretary  of  the  Treasury  having  accumulated  a  specie  reserve  of 
about  $100,000,000  for  this  purpose.  The  sum  of  greenbacks 
left  in  circulation  was  $346,681,016,  and  it  became  the  accepted 
idea  that  the  government  would  retain  a  reserve  of  $100,000,000 
in  gold  for  their  redemption.  This  reserve  proved  sufficient  until 
the  redemptions  during  the  depression  that  followed  the  panic  of 
1893,  when  an  endless  chain  of  redemptions  and  reissues  threat- 
ened to  extinguish  the  reserve;  the  balance  of  trade  was  adverse 
and  holders  of  greenbacks  presented  them  for  gold  to  ship  abroad, 
but  because  of  deficits  the  Treasury  was  forced  to  reissue  the 
redeemed  notes  to  meet  its  ordinary  expenses.  To  replenish  the 
reserve,  the  Treasury  sold  bonds  for  gold. 

In  1900  a  separate  reserve  fund  of  $150,000,000  was  authorized 
and  adequate  powers  were  extended  to  the  Secretary  of  the 
Treasury  for  maintaining  it;  the  fund  was  to  be  separated  from 
the  general  Treasury  funds;  the  greenbacks  when  redeemed  were 
not  to  be  reissued  until  the  fund  was  again  replete;  the  Treasury 
was  to  pay  any  gold  in  its  possession  into  this  fund  to  refill  it,  and 
was  also  empowered  to  sell  bonds  to  fill  the  reserve  when  it  should 
drop  below  $100,000,000.  By  the  Federal  Reserve  Act  in  1913 
the  government's  share  of  the  net  earnings  of  the  federal  reserve 
banks  may,  at  the  discretion  of  the  Secretary  of  the  Treasury,  be 
used  to  supplement  the  $150,000,000  reserve. 

These  greenbacks  are  promises  of  the  United  States  to  pay  on 
demand.  Between  1862  and  1879  this  promise  was  not  kept  and 
the  notes  possessed  all  the  features  of  inconvertible  paper;  but 
since  1879  tnev  nave  Deen  convertible  and  at  par.    They  are  now 


GOVERNMENT  PAPER  OR  CREDIT  MONEY 


57 


legal  tender  for  payment  of  all  debts,  public  and  private,  except 
for  payment  of  interest  on  government  debt  and  for  payment  of 
revenue  duties.  The  denominations  issued  are  i, coo's,  500's, 
ioo's,  5o's,  20's,  io's,  5's,  2%  and  i's.  As  a  constituent  of  our 
money  system  they  are  a  menace,  are  an  inelastic  form  of  cur- 
rency, and  should  be  redeemed  and  discarded.  Their  menace 
becomes  less  as  they  come  to  constitute  a  smaller  fraction  of  our 
total  circulating  media,  as  they  become  bills  of  smaller  denomina- 
tions, and  as  the  reserve  becomes  larger — all  of  which  tendencies 
are  now  at  work.  . 

Treasury  Notes  of  1890 

The  treasury  notes  of  1890  are  similar  to  the  greenbacks  in 
quality.  They  were  issued  under  the  Sherman  Silver  Law  of  that 
year  to  pay  for  the  silver  bought  by  the  government.  They 
created  an  additional  demand  upon  the  gold  reserve  against  the 
greenbacks,  which  was  already  too  small.    The  issues  are: 

Issue  and  Retirement  of  Treasury  Notes 

(In  millions) 


Fiscal 
Year 

Treasury 
Notes 
Issued 

Silver  Dollars 

Coined  from 

Bullion  of  Act 

of  1890 

Amount  of  Treasury 
Notes   Redeemed   in 
Silver  and  Canceled 

Amount  of 
Treasury  Notes 
Outstanding 

1891 
1892 

1893 
1894 

1895 
1896 
1897 
1898* 

$  50-5 

45-5 
8-7 

$27-3 

3-4 

5-3 

.0 

3-9 

7-5 

21.2 

3-8 

$  3-3 

6-5 

16.4 

14.8 

8-5 

$  50.2 
101.7 
147.2 
152.6 
146.0 
129.7 

H4-9 
106.3 

Total. . . 

$155-9 

$72.6 

$49.6 

*  First  6  months  only. 


58  MONEY,  CREDIT,  AND  BANKING 

The  Act  of  1900  provided  for  the  retirement  of  an  amount 
equal  to  the  amount  of  silver  coined  from  that  bought  with  the 
notes;  this  has  now  all  been  coined  and  as  the  notes  are  turned  in 
for  redemption,  silver  certificates  are  substituted  for  them.  Of 
the  $155.9  millions  originally  issued,  only  $1.7  millions  were 
outstanding  September  1,  19 19;  there  are  probably  very  few  in 
existence,  and  most  of  thesowill  be  held  as  souvenirs  and  in 
numismatic  collections.  They  are  redeemable  on  demand  in 
either  gold  or  silver,  at  the  discretion  of  the  Secretary  of  the 
Treasury. 

Gold  and  Silver  Certificates 

The  United  States  has  two  forms  of  representative  paper 
money,  the  gold  certificate  (or  note)  and  the  silver  certificate. 
In  1863  Congress  authorized  the  issue  of  gold  notes  against  de- 
posits of  gold  coin  and  bullion.  They  are  receipts  for  the  gold 
coin  and  redeemable  in  gold.  They  were  not  legal  tender  until 
1920,  but  have  been  receivable  for  customs,  taxes,  and  all  public 
dues,  and  previous  to  July  15,  1916,  might  be  used  as  reserves  in 
national  banks.  The  denominations  issued  are  10,000's,  5, coo's, 
1,000's,  500's,  ioo's,  5o's,  20's,  and  io's.  The  gold  held  to  redeem 
these  notes  may  be  coined  or  uncoined;  by  an  Act  of  19 16  two- 
thirds  may  be  kept  in  bullion  form. 

The  silver  certificates  were  authorized  by  Congress  in  1878, 
to  facilitate  the  circulation  of  the  standard  silver  dollar.  They 
are  redeemable  in  silver  only  and  are  not  legal  tender,  but  are 
receivable  for  all  public  debts,  customs,  and  taxes.  By  the  Act  of 
1878  the  denominations  issued  were  1,000's,  500's,  ioo's,  50's, 
20's,  io's,  2's,  and  i's.  In  1891  an  act  was  passed  limiting  the 
denominations  to  $10  and  under,  except  that  one-tenth  of  the  total 
issue  might,  in  the  discretion  of  the  United  States  Treasurer,  be 
issued  in  denominations  of  20's,  50's,  and  ioo's.  The  large  notes, 
when  redeemed  by  the  Treasurer,  are  retired  and  canceled,  and 
certificates  of  the  denominations  of  io's  or  less  substituted.    The 


GOVERNMENT  PAPER  OR  CREDIT  MONEY  59 

Pittman  Act  of  1918  made  provision  for  the  reduction  of  silver 
dollars  to  bullion  for  shipment  to  India.  This  forced  the  retire- 
ment of  silver  certificates  representing  the  silver  dollars.  The 
federal  reserve  banks  issued  a  request  to  the  member  banks  to 
forward  at  their  expense  all  silver  certificates  above  $5  denomina- 
tion and  to  receive  in  their  place  federal  reserve  bank  notes;  a 
little  later  smaller  denomination  certificates  were  called  in  and 
federal  reserve  bank  notes  given  in  exchange.  This  process  ended 
in  1919,  as  the  emergency  of  the  war  passed.  These  federal  re- 
serve bank  notes  are  being  replaced  by  silver  certificates  as  silver 
is  purchased  by  the  government  to  replenish  its  stock. 

Gold  Order  Certificates 

One  other  form  of  government  certificate  is  the  gold  order 
certificate,  issued  at  the  discretion  of  the  Treasurer  of  the  United 
States,  against  deposits  of  gold  coin  or  gold  bearer  notes,  of  ten- 
thousand  denomination  only.  Prior  to  July  1,  19 14,  the  sub- 
treasury  in  New  York  issued  this  form  of  certificate  to  the  order 
of  the  New  York  Clearing  House  in  settlement  of  its  debit  bal- 
ances. Such  certificates  were  formerly  carried  by  the  national 
banks  as  part  of  their  reserve. 

Federal  Reserve  Notes 

The  federal  reserve  notes  are  obligations  of  the  United  States 
government  and  are,  strictly  speaking,  a  form  of  government 
paper  money,  but  their  qualities  and  the  method  of  issue  can  be 
more  easily  treated  in  Volume  II,  Chapter  XIX. 

Method  of  Issuance 

The  United  States  Treasury  has  Divisions  of  Issue  and 
Redemption,  to  which  are  assigned  respectively  the  accounts  relat- 
ing to  the  issue  and  redemption  of  United  States  notes,  gold  certif- 
icates, silver  certificates,  and  currency  certificates.  The  federal 
reserve  notes,  the  federal  reserve  bank  notes,  and  the  national 


60  MONEY,  CREDIT,  AND  BANKING 

bank  notes,  against  which  redemption  funds  are  specifically  kept, 
are  issued  and  redeemed  through  the  Comptroller  of  the  Currency. 
The  reserve  fund  for  redemption  of  United  States  notes  and  treas- 
ury notes,  the  gold  coin  and  bullion  held  against  outstanding  gold 
certificates,  and  the  silver  dollars  and  bullion  held  against  out- 
standing silver  certificates,  are  held  as  separate  trust  funds  for 
the  redemption  of  the  notes  or  certificates  for  which  they  are  re- 
spectively pledged,  and  can  be  used  for  no  other  purpose. 

New  United  States  notes  are  issued  upon  request  in  return  for 
United  States  notes  unfit  for  circulation,  also  for  federal  reserve 
notes,  federal  reserve  bank  notes,  national  bank  notes,  subsidiary 
silver  coin,  or  minor  coin,  received  for  redemption  or  exchange. 
Gold  certificates  are  issued  by  the  Treasurer  upon  deposit  of 
gold  coin  and  silver  certificates  upon  deposit  of  standard  silver 
dollars. 

Method  of  Redemption 

United  States  notes  and  gold  certificates  are  redeemable  by 
the  Treasurer  in  gold  coin,  treasury  notes  of  1890  in  gold  coin 
or  silver  dollars,  and  silver  certificates  in  silver  dollars.  National 
bank  notes  and  federal  reserve  bank  notes  are  redeemable  in 
lawful  money  by  the  Treasurer,  and  also  over  the  counter  of  the 
issuing  bank.  Federal  reserve  notes  are  redeemable  in  gold  by  the 
Treasurer. 

Since  the  abolition  of  the  subtreasuries  in  1920-1921,  the 
federal  reserve  banks  have  redeemed  United  States  currency, 
national  bank  notes,  federal  reserve  bank  notes,  and  coin  for 
non-member  banks,  business  concerns,  and  individuals.  It  is 
not  necessary  to  effect  such  redemptions  for  the  member  banks 
inasmuch  as  they  may  forward  paper  money  or  coin,  whether 
fit  or  unfit  for  circulation,  to  the  federal  reserve  bank  for  credit 
to  their  reserve  account,  and  they  may  order  paper  money  or 
coin  fit  for  circulation  from  this  bank  as  needed. 

All  United  States  notes,  treasury  notes,  and  gold  and  silver 


GOVERNMENT  PAPER  OR  CREDIT  MONEY  6l 

certificates  unfit  for  circulation,  when  not  mutilated  to  a  greater 
extent  than  two-fifths  of  the  whole,  are  redeemed  by  the  govern- 
ment at  their  full  face  value.  All  notes  mutilated  so  that  less 
than  three-fifths,  but  clearly  more  than  two-fifths,  remain,  are 
redeemed  by  the  Treasurer  at  Washington  at  one-half  the  face 
value  of  the  whole  note.  Fragments  less  than  three-fifths  may 
be  redeemed  at  full  face  value  if  accompanied  by  an  affidavit  of 
the  owner  that  the  missing  portions  have  been  totally  destroyed; 
this  affidavit  must  state  the  cause  and  manner  of  the  mutilation 
and  must  be  sworn  to  by  a  notary. 

When  remittances  are  received  for  redemption  by  the  Treas- 
ury from  a  place  in  which  there  is  no  federal  reserve  bank  or 
branch  bank,  returns  are  made  in  new  United  States  notes,  sub- 
sidiary silver,  or  minor  coin,  by  mail  (postage  and  insurance 
deducted)  unless  requested  otherwise,  in  which  case  the  charges 
for  transportation  are  paid  by  the  consignee.  If  the  remittances 
are  received  from  a  place  in  which  there  is  a  federal  reserve  bank 
or  branch  bank,  the  Treasurer  may  make  returns  by  check  pay- 
able at  the  federal  reserve  bank  or  branch  bank,  if  it  suits  his 
convenience. 

Paper  currency  for  redemption  must  be  assorted  by  kinds  and 
denominations,  and  each  ioo  notes  or  less  enclosed  in  a  paper 
strap  marked  with  the  amount.  The  Treasury  gives  other  in- 
structions in  case  of  large  packages.  With  each  package  should 
be  enclosed  a  memorandum  giving  an  inventory  of  the  contents, 
the  sender's  name  and  address,  and  the  disposition  to  be  made  of 
the  proceeds.  United  States  notes,  treasury  notes  of  1890,  gold 
certificates,  and  silver  certificates  may  be  sent  in  the  same  pack- 
age and  should  be  marked  "Unfit  United  States  currency  for 
redemption."  National  bank  notes,  federal  reserve  notes,  and 
federal  reserve  bank  notes  may  be  sent  in  the  same  package, 
marked  "National  and  federal  reserve  currency  for  redemption." 
Charges  are  paid  by  the  government  on  unfit  national  bank  notes, 
federal  reserve  notes,  and  federal  reserve  bank  notes,  when  sent  to 


62  MONEY,  CREDIT,  AND  BANKING 

the  department  at  Washington  "charges  collect,"  but  not  on  any 
other  kind  of  currency. 

The  total  redemptions  during  the  fiscal  year  19 19  were: 

United  States  currency $73 1 -4  millions 

Federal  reserve  notes 877.3        " 

Federal  reserve  bank  notes 31.8        " 

National  bank  notes 294.2        " 

Money  Circulating  in  the  United  States 

The  total  money  in  circulation  in  the  United  States  on  June 
30  in  recent  years  is  shown  in  the  following  table : 

Money  in  Circulation  in  the  United  States,  June  30 

(In  millions) 


1914 

1915 

1916 

1917 

1918 

1919 

1920 

$  611 

1,026 

70 

478 

159 

337 

2 

$  590 

1,072 

64 

481 

159 

332 

2 

$  637 

1,413 

66 

489 

171 

34i 

2 

$1,036 

1,392 

71 

477 

193 

335 

I 

$1,114 
818 
77 
379 
216 
340 
I 

$1,172 
542 
81 
169 
232 
332 
1 

$  834 

390 
134 
118 

Standard  silver  dollars 

251 
337 

Total 

$2,683 

$2,700 

$3,H9 

$3,505 

$2,945 

$2,529 

$2,066 

$  715 

$   80 
785 

$  173 

728 

$  544 

12 

698 

$1,713 

15 

703 

$2,493 
163 
649 

$3,122 
199 
696 

Total 

$  715 

$  865 

$  901 

$1,254 

$2,531 

$3,305 

$4,018 

Grand  Total  Circulation 

13,398 

$3,565 

$4,020 

$4-759 

$5,476 

$5,841 

$6,084 

134-35 

$35-44 

$39-28 

$45-74 

$50.81 

$54-28 

$56.79 

The  decrease  in  the  silver  certificates  and  the  increase  in  the 
federal  reserve  bank  notes  are  explained  by  the  operations  of  the 
Pittman  Act  described  above.  The  increase  in  gold  coin  and  bul- 
lion is  due  to  the  heavy  importations  from  abroad  during  the  war, 


GOVERNMENT  PAPER  OR  CREDIT  MONEY 


63 


t  B 

II 


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GOVERNMENT  PAPER  OR  CREDIT  MONEY  65 

to  the  production  of  the  mines,  and  to  the  reduction  of  plate  and 
the  like.  The  reason  for  the  decrease  in  the  gold  certificates  and 
the  increase  in  the  federal  reserve  notes  will  be  explained  in 
Volume  II,  Chapter  XII.  The  increase  in  subsidiary  silver  cur- 
rent is  explained  by  the  greater  population,  the  higher  price  level, 
and  the  fractional  prices  charged  for  various  services  and  goods. 
Certain  changes  in  marketing  methods,  such  as  the  use  of  slot 
automatic  machines,  also  occasion  greater  need  for  small  change ; 
in  prosperous  times  more  people  have  money  on  their  persons, 
particularly  small  coins.  The  decrease  in  notes  of  1890  has  been 
explained.  It  is  evident  from  the  table  that  the  money  in  circula- 
tion is  fast  becoming  the  various  forms  of  bank  notes. 

The  paper  currency  of  each  denomination  outstanding  on 
June  30  and  its  location,  as  well  as  other  statistical  data,  are  given 
in  the  preceding  table. 

VOL.  I — S 


CHAPTER  V 

NATURE   OF  BANK   CREDIT 

Specialization  in  Credit  Issue 

The  credits  issued  by  the  government  are  incidental  to  its 
major  functions  of  making,  executing,  and  interpreting  the  law. 
The  credits  issued  by  the  business  man  are  incidental  to  the  con- 
duct of  his  commercial  operations.  The  personal  credits  issued 
are  occasional  and  for  personal  consumptive  uses.  None  of  these 
parties  specializes  in  the  issue  of  credits  or  devotes  time  primarily 
to  that  function.  The  commercial  banks  have  undertaken  this 
specialized  function.  Their  business  is  the  issue  and  guaranty  of 
credits  for  business  uses;  they  are  dealers  in  credits,  and  are  some- 
times, although  too  narrowly,  called  "manufacturies"  of  credit. 
As  will  appear  in  the  later  chapters  on  banking  practices,  com- 
mercial banks  function  in  many  ways  which  do  not  bear  strictly 
upon  credits,  and  which  concern  financial  as  well  as  commercial 
credits.  The  fundamentals  of  banking,  however,  are  most  easily 
grasped  from  the  point  of  view  of  purely  commercial  credit  opera- 
tions. 

Forms  of  Bank  Credit 

The  liabilities  of  a  bank  to  creditors  take  four  chief  forms: 

i.  Deposits 

2.  Bank  notes 

3.  Acceptances  and  letters  of  credit 

4.  Bills  payable 

Deposits  are  rights  to  draw  on  the  bank  for  money.  A  deposi- 
tor commonly  gets  such  rights  in  one  or  more  of  the  following 
possible  ways: 

66 


NATURE  OP  BANK  CREDIT  67 

1.  By  the  deposit  of  cash  or  cash  items. 

2.  By  depositing  time  items  for  collection  and  credit. 

3.  By  remitting  securities  or  other  property  to  the  bank  for 

sale  and  credit. 

4.  By  the  process  of  loan  and  discount. 

5.  By  the  sale  of  securities,  real  estate,  personalty,  or  services 

to  the  bank  for  credit. 

Bank  notes  are  promises  of  the  bank  to  pay  money  on  demand; 
issued  in  round  denominations  and  transferable  without  indorse- 
ment, they  are  designed  to  circulate  in  lieu  of  metallic  money. 
The  transferee  becomes  the  noteholder  and  creditor  of  the  bank; 
the  bank  note  may  come  into  his  hands  in  the  ordinary  transac- 
tions of  his  business,  or  through  any  one  of  the  five  methods  de- 
scribed above  by  which  a  depositor  gets  deposits. 

Acceptances  are  bills  of  exchange  drawn  on  the  bank,  which, 
for  a  commission,  it  obligates  itself  to  pay,  but  to  provide  funds 
for  which  payment  the  person  for  whom  the  letter  of  credit  is 
procured  is  obligated  to  the  bank.  Letters  of  credit  are  agree- 
ments by  the  bank  to  accept,  and  to  pay  at  maturity  or  demand, 
bills  of  exchange  drawn  under  certain  specified  conditions. 

Bills  payable  are  promissory  notes,  secured  or  unsecured, 
interest-bearing,  and  running  for  a  period  of  time,  by  which  a 
bank  borrows  in  large,  irregular  sums,  at  various  times. 

Sometimes  the  borrowing  is  done  by  selling  some  of  the  bills 
receivable,  acceptances,  or  other  commercial  paper  which  the 
bank  has  in  its  portfolio,  a  process  which  incurs  the  contingent 
liability  of  indorsement  or  agreement  to  repurchase. 

Bank  credit  extensions  more  commonly  take  the  forms  of  de- 
posits and  bank  notes,  and  therefore  the  theory  of  these  two 
forms  will  be  fully  developed. 

Nature  of  Cash  Deposits 

Suppose  a  person,  Mr.  White,  from  motives  of  hire,  public 
interest,  or  business  efficiency,  undertakes  to  accept  moneys  from 


68  MONEY,  CREDIT,  AND  BANKING 

a  certain  number  of  persons,  Messrs.  Black,  Brown,  Green,  and 
Blue,  who  have  mutual  business  transactions,  to  act  as  trustee 
and  common  custodian  of  the  funds,  to  keep  a  record  of  receipts 
and  withdrawals,  and  to  permit  and  care  for  the  transfer  of  title 
to  these  funds  on  his  books.  The  transfer  of  title  to  these  funds 
would  become  the  common  method  of  payment  in  their  business 
transactions.  Such  transfers  would  be  accomplished  most  easily 
by  Black  ordering  White  to  debit  his  account  a  certain  number 
of  dollars  and  to  credit  Brown's  account  the  same  number  of 
dollars;  other  orders  might  be  written  by  Green  on  White  in  favor 
of  Black,  and  by  Blue  on  White  in  favor  of  Brown,  and  so  forth. 
If  a  number  of  such  orders  were  presented  to  White,  all  the  pay- 
ments could  be  handled  by  the  simple  cancellation  of  debits  and 
credits  on  his  books.    Trade  would  be  much  convenienced. 

Instead  of  White  acting  in  the  capacity  of  trustee,  the  traders, 
Black,  Brown,  Green,  and  Blue,  might  be  content  to  loan  White 
the  funds  on  his  promise  to  repay  the  loaner,  or  the  person  pre- 
senting the  loaner 's  written  order,  on  demand;  title  to  the  funds 
would  then  pass  to  White,  while  the  traders  would  become  de- 
mand creditors  of  White  with  rights  to  draw  on  that  credit  at 
their  pleasure.  These  rights  to  draw  are  deposits,  and  in  this 
case  they  arise  through  the  deposit  of  cash.  White  is  essentially 
a  bank  of  deposit.  The  orders  for  withdrawals  are  checks  or 
drafts.  White's  balance  sheet  (supposing  he  had  no  other  funds 
or  wealth)  would  then  stand  as  follows : 

Assets                                                  Liabilities 
Cash $100,000      Deposits V  $100,000 

Items  for  deposit  may  consist  of  cash  or  cash  items,  "cash 
items"  being  the  term  applied  to  items  payable  on  demand.  Im- 
mediate credit  would  be  given  by  White  (the  receiving  bank)  for 
cash,  and  might  also  be  given  for  cash  items  received  for  collec- 
tion.   The  receiving  bank  (White  in  this  case)  has  usually  a  defi- 


NATURE  OF  BANK  CREDIT  69 

nite  policy  to  which  it  adheres  in  this  matter;  it  usually  gives  credit 
only  after  collection  or  after  the  average  time  consumed  in  making 
such  collections.  If  interest  were  being  paid  on  the  deposits  or 
if  the  depositor  expected  to  draw  at  once  against  his  credit,  the 
bank  would  be  likely  to  delay  credit  until  collection  had  been 
made.  Collections  on  institutions  in  the  city  or  the  vicinity 
would  thus  receive  credit  sooner  than  items  on  more  distant  in- 
stitutions; clearing  house  items  would  be  given  immediate  credit. 

Motives  in  Depositing  Cash  Funds 

Customers  have  various  motives  in  making  deposits  of  cash 
funds.  One  motive  is  the  desire  for  safety.  The  depositor  gives 
up  his  right  to  any  particular  cash  when  he  makes  a  deposit;  he 
cannot  properly  say  he  has  "money  in  the  bank";  he  has  simply 
the  right  to  draw  money  from  the  bank,  and  it  is  very  unlikely 
that  he  would  get  back  the  identical  cash  which  he  actually  de- 
posited. If  the  depositor  thinks  in  terms  of  the  extraordinary 
facilities  which  the  bank  has  for  the  safe-keeping  of  its  moneys 
and  valuables,  he  is  quite  likely  to  err  as  to  the  exact  nature  of 
deposits.  He  may  make  a  "special  deposit,"  having  the  banker 
"earmark"  it  and  keep  it  out  of  the  general  fund  of  the  bank's 
cash,  so  that  the  identical  money  deposited  can  be  repaid;  but 
this  would  be  rather  a  warehouse  business  than  commercial 
banking,  and  deposits  are  not  of  this  nature.  The  safe-keeping, 
therefore,  when  rightly  understood,  refers,  not  to  the  depositor's 
funds,  but  to  the  bank's  funds.  The  depositor's  funds  are  safe 
only  in  the  sense  that  a  claim  against  the  bank  is  good  and  the 
facilities  for  safe-keeping  (vaults,  guards,  burglar  alarms,  etc.) 
of  the  bank's  funds  add  to  the  value  of  a  depositor's  claims. 

Another  motive  for  depositing  cash  funds  with  a  bank  is 
convenience.  Payment  by  check  is  more  convenient  than  pay- 
ment by  money.  The  use  of  checks  saves  the  bother  and  expense 
of  counting  and  of  shipment;  checks  are  relatively  safe  against 
theft  and  loss  in  transit;  they  are  payable  only  to  the  payee  or 


70  MONEY,  CREDIT,  AND  BANKING 

indorsee;  the  voucher  becomes  a  receipt;  and  large  sums  may  be 
paid  with  the  same  ease  as  small  ones. 

A  third  motive  may  be  the  receipt  of  interest  on  the  deposits. 
In  communities  where  the  competition  for  accounts  is  intense, 
banks  offer  interest  on  the  average  balance  carried  by  the  de- 
positor; this  is  especially  likely  in  the  case  of  large  accounts,  as  of 
the  governmental  units,  corporations,  or  other  banks.  The  inter- 
est paid  ranges  from  2  to  4  per  cent,  varying  with  the  account 
and  the  bank.  The  policy  of  the  bank  may  be  open,  explicit,  and 
the  same  to  all,  or  arrangements  with  the  depositor  may  be  secret. 
Paying  interest  on  deposits  is  discouraged  by  bankers,  for  it 
adds  to  the  expenses,  forces  the  bank  to  negotiate  loans  which 
have  high  earning  capacity  but  inadequate  security,  and  at  times, 
when  deposits  are  increasing  faster  than  loans  or  when  the  market 
money  rates  are  low,  eats  up  the  bank's  profits.  If  interest  is 
paid,  it  should  be  done  sparingly  and  on  a  sliding  scale  of  rates 
which  varies  with  the  market  rate,  and  the  burden  should  be  on 
time  deposits. 

The  bank  performs  many  services  for  the  depositor  which, 
because  of  its  large  clientele  and  organization,  it  is  better  equipped 
to  perform  than  the  depositor  himself.  It  collects  his  cash  items 
and  other  papers  through  its  clearing  house,  messengers,  or  transit 
and  collection  departments;  it  keeps  and  cares  for  his  securities, 
and  upon  order  will  buy  or  sell  these  for  him;  it  offers  free  advisory 
service  about  credits,  market  conditions,  signatures,  and  so  forth. 
The  exact  nature  of  these  and  other  services  which  are  tendered 
to  the  depositor  who  maintains  with  the  bank  a  fair  dependable 
balance,  will  appear  in  the  following  chapters. 

A  more  important  motive  than  any  of  these  is  bank  "accom- 
modation," as  it  is  called.  The  depositor  wishes  to  be  assured 
that  he  will  have  someone  from  whom  he  can  get  loans  in  case  of 
need,  and  a  bank  which  has  enjoyed  the  use  of  a  good  balance  from 
a  worthy  customer  assumes  an  implicit  responsibility  to  accom- 
modate that  depositor  with  loans  when  appeal  is  made.    In  this 


NATURE  OF  BANK  CREDIT  7 1 

sense  the  relations  between  customer  and  bank  are  mutual.  In 
the  depositor's  daily  business  transactions,  occasions  frequently 
arise  when  he  wishes  to  procure  loans  on  his  own  note  or  by  the 
discount  of  paper  in  his  portfolio,  and  the  bank  stands  ready  to 
provide  customers  with  its  own  credit  in  exchange  for  their  credit 
or  that  of  other  persons.  The  bank  offers  a  market  for  procuring 
and  selling  credits  and  so  facilitates  business  in  this  incomparable 
way. 

Nature  of  Loans 

The  last  paragraph  introduces  the  subject  of  loans  and  dis- 
counts. The  person  or  bank,  here  termed  "  White,"  soon  observes 
that,  although  payments  of  checks  are  being  continually  made, 
cash  is  as  continually  being  redeposited  by  the  payee  or  others; 
that,  although  payments  and  receipts  are  not  synchronous  or 
equal  in  amount,  there  is  a  continuous  balance  left  in  his  hands, 
which  varies  but  little  in  amount.  As  there  is  slight  probability 
that  all  depositors  will  at  one  time  demand  the  full  amount  of 
their  deposits,  White  is  therefore  safe  in  loaning  to  any  would-be 
borrowers,  on  their  promissory  notes,  a  sum,  say,  of  $45,000. 
White's  balance  sheet  would  then  stand  as  follows: 

(1)  If  cash  is  paid  out  to  the  borrowers: 

Assets  Liabilities 

Cash $55,000      Deposits $100,000 

Loans    (promissory   notes 
of  borrowers) 45,000 

or  (2)  if  the  borrowers  preferred  to  leave  the  funds  on  deposit 
with  White,  subject  to  later  withdrawal: 

Assets  Liabilities 

Cash $100,000      Deposits $145,000 

Loans  (promissory  notes 
of  borrowers) 45, 000 


72  MONEY,  CREDIT,  AND  BANKING 

In  this  process  deposits  have  been  created;  the  borrower  has 
come  to  possess  rights  to  draw  money  from  White,  although  the 
cash  which  he  nominally  borrowed  and  redeposited  at  no  time 
left  the  possession  and  ownership  of  White.  From  the  borrower, 
White  has  accepted  an  interest-bearing  promissory  note  payable 
at  a  specified  date,  and  in  exchange  for  this  note  has  given  the 
borrower  the  right  to  draw  on  him  to  the  amount  of  the  note,  with 
the  implied  agreement  that  he  will  pay  such  requisitions  on  de- 
mand. The  ratio  of  his  cash  to  his  demand  liabilities  has  been 
changed  from  ioo:  ioo  to  55: 100,  or  100: 145.  White  does  not 
normally  allow  interest  to  Black  for  such  credits,  however  long  it 
may  be  until  Black  demands  payment  of  them;  rather  than  allow 
interest  on  deposits  created  by  loans,  the  rate  of  interest  on  the 
loan  would  be  lowered.  Receiving  interest-bearing  promissory 
notes  in  exchange  for  the  right  of  the  depositor  to  draw  later  is, 
in  effect,  lending  with  interest  and  borrowing  without  interest, 
by  means  of  which  White  is  able  to  make  a  profit,  which  is  the 
motive  of  his  business. 

Nature  of  Discounts 

It  may  be  supposed  that  the  loans  placed  by  White  in  this 
way  do  not  exhaust  the  sum  that  may  be  loaned  by  him  without 
endangering  his  ability  to  meet  all  demands  made  upon  him,  and 
that  some  of  his  customers  have  promissory  notes,  bills  of  ex- 
change, or  acceptances,  which  have  come  into  their  hands  in  the 
daily  transactions  of  their  businesses  and  which  they  are  willing 
to  sell.  White  may  buy  these  to  the  face  amount,  say,  of  $35,000, 
but  he  will  pay  less  than  their  face  value  by  the  amount  of  the 
interest  on  their  face  value  till  due.  This  interest  is  taken  in  ad- 
vance, and  the  proceeds  are  either  paid  in  cash  or  credited  as  de- 
posits to  the  parties  selling  the  paper.  The  interest  taken  in  ad- 
vance and  calculated,  not  on  the  sum  actually  paid  in  cash  or 
credited  as  deposits  (that  is,  the  sum  actually  loaned)  but  on  the 
face  of  the  paper,  is  called  "  discount,"  and  the  act  of  selling  a  note 


NATURE  OF  BANK  CREDIT  73 

when  discount  is  taken  is  called  "discounting"  the  paper.    At 
the  time  when  White  buys  the  paper  the  discount  is  not  yet 
earned,  but  it  is  nevertheless  credited  at  once.    His  balance  sheet, 
based  on  the  last  above,  will  then  stand: 
(1)  If  cash  is  paid: 

Assets  Liabilities 

Cash $66,000     Deposits $145,000 

Loans  (promissory  notes  Discount 1,000 

of  borrowers) 45, 000 

Discounts         (promissory 

notes  and  other  paper 

discounted) 35, 000 

or  (2)  if  paid  by  creating  deposits: 

Assets  Liabilities 

Cash $100,000      Deposits $1 79,000 

Loans 45,ooo      Discount 1,000 

Discounts 35,000 

The  process  of  discount  results  in  the  creation  of  deposits,  in 
much  the  same  manner  as  did  loans.  White  has  now  in  his  port- 
folio commercial  papers  bearing  the  names  of  makers,  drawers, 
and  indorsers — claims  against  these  parties,  these  claims  being 
earning  assets,  with  the  earnings  taken  in  advance.  In  exchange 
for  these  White  has  given  either  cash  or  deposits.  If  cash  is  paid, 
the  payee  may  possibly  redeposit  it.  The  discount  is  profit,  since 
no  interest  is  allowed  on  the  credits  which  White  gives  the  seller 
of  the  paper. 

Effect  of  Loans  and  Discounts  on  Deposits 

Under  the  circumstances  just  mentioned,  White's  ability  to 
loan  and  discount  further  is  decreasing;  the  ratio  of  his  cash  to  his 
demand  liabilities  has  decreased  from  55:  100  (or  100:145)  to 
66: 145  (or  100:  179).  The  larger  the  deposits,  the  larger  abso- 
lutely the  demands  that  may  be  made  for  payment;  hence  the 


74  MONEY,  CREDIT,  AND  BANKING 

cash  left  on  hand  may  barely  suffice  to  meet  them.  On  the  other 
hand,  the  larger  the  loans  and  discounts,  the  larger  the  profits. 
White  is  tempted,  therefore,  to  make  loans  and  discounts,  hus- 
banding his  cash  and  creating  deposits,  to  such  an  amount  as  will 
bring  the  greatest  profits  and  yet  be  within  the  bounds  of  safety. 

Crediting  the  proceeds  of  loans  and  discounts  is  the  usual 
method  of  creating  deposits.  "Loans"  is  the  term  applied  to  the 
extension  of  cash  or  credits  to  a  customer  on  his  own  note.  The 
lender,  White,  will  require  interest  for  the  time  the  borrower  has 
the  funds;  the  interest  will  be  payable,  however,  not  in  advance 
but  at  maturity  of  the  principal.  The  note  is  usually  drawn  with 
interest  at,  say,  4  per  cent  for  the  period  of  the  loan,  but  it  may 
be  drawn  without  interest,  in  which  case  the  principal  of  the  note 
is  made  large  enough  to  cover  the  amount  of  the  actual  cash  or 
credit  advanced  plus  interest  thereon.  "Discounts"  is  the  term 
applied  to  extensions  of  cash  or  credits  to  persons  selling  notes 
or  other  commercial  credit  instruments,  of  which  the  makers  or 
drawers  are  usually  third  persons,  at  prices  less  than  their  face 
value  by  the  amount  of  the  interest  on  their  face  value  till  due. 
The  buyer,  White,  calculates  the  "discount"  at  his  "discount 
rate,"  deducts  it  from  the  face  value,  and  pays  the  seller  the 
"proceeds"  in  cash,  or  credits  them  to  his  account.  The  two 
operations  are  essentially  the  same  and  result  in  the  creation  of 
deposits.  The  financial  statements  of  banks  group  these  two 
assets  together  as  Loans  and  Discounts. 

Discount,  then,  is  not  a  distinct  function  of  commercial  banks, 
but  one  of  the  methods  of  creating  deposits.  The  promissory 
note  or  discounted  item  becomes  the  property  of  the  bank  to 
which  the  promissor  is  bound  to  make  payment  at  maturity;  the 
note  is  listed  among  the  assets,  and  at  maturity  the  bank  will  re- 
ceive the  face  amount.  The  volume  of  deposits  varies  directly 
with  the  amount  of  loans  and  discounts.  The  borrower  gives  his 
promise  to  pay  the  bank  (and  the  seller  of  discount  paper  gives  the 
promises  of  himself  or  third  parties  to  pay  to  his  indorsee,  the  bank) 


NATURE  OF  BANK  CREDIT  75 

and  in  exchange  gets  cash  or  the  right  to  draw  at  will  on  the  bank 
with  the  implicit  promise  of  the  bank  to  honor  his  requisitions. 

Rationale  of  Exchange  of  Credits 

The  rationale  of  this  exchange  of  credits  is  that  the  seller  (or 
borrower)  gives  less  widely  known  credit  for  the  more  widely 
known  credit  of  the  bank.  The  bank  essentially  guarantees  the 
private  credits,  the  bank  credit  being  more  widely  accepted  and 
therefore  more  useful  to  the  customer  in  his  business  operations. 

The  exact  nature  of  this  substitution  or  guaranty  of  credits 
should  be  fully  perceived,  for  it  constitutes  the  fundamental 
principle  of  commercial  banking.  There  is  an  exchange  of  less 
known  credit  for  better  known  credit;  of  less  useful  credit  for  more 
useful  credit;  of  credit  in  which  the  time  element  is  considerable 
for  credit  in  which  the  time  element  is  inconsiderable,  the  check 
or  draft  on  a  bank  being  payable  upon  demand ;  of  credit  subject 
to  interest  and  discount  for  credit  freed  from  such  depreciation. 

To  illustrate,  suppose  a  retailer  buys  goods  from  a  jobber  on 
30  days'  time.  The  common  methods  of  financing  the  transaction 
are  three.  The  first  method  is  for  the  jobber  to  carry  the  retailer 
on  open  account  for  30  days.  In  this  case  the  jobber  will  probably 
have  to  borrow  at  his  bank  funds  to  meet  his  own  debts  maturing 
meanwhile.  He  gives  his  own  note,  payable  to  the  bank,  and  gets 
in  exchange  deposit  rights  which  he  transfers  by  check  to  his 
creditors.  The  bank  in  this  way  becomes  the  direct  presumptive 
debtor  to  these  creditors,  and  remains  so  until  the  checks  are  pre- 
sented and  paid.  Such  an  operation  is  a  substitution  of  credits. 
But  the  jobber  was  able  to  get  this  substitution  only  by  showing 
to,  or  pledging  with,  the  bank  his  account  receivable,  that  is,  the 
retailer's  credit,  the  retailer's  implied  promise  to  pay  in  30  days. 
The  bank  accepted  the  jobber's  credit,  supported  by  a  contingent 
right  to  the  retailer's  credit,  giving  in  return  its  own  credit.  The 
bank  accepted  credit  items  in  which  the  time  element  was  con- 
siderable and  gave  demand  credit  items. 


76  MONEY,  CREDIT,  AND  BANKING 

The  second  method  is  for  the  retailer  to  give  to  the  jobber  a 
promissory  note  for  30  days,  or  to  accept  (that  is,  sign)  a  draft 
drawn  on  him  by  the  jobber  by  which  the  retailer  agrees  to  pay  in 
30  days.  The  jobber  can  indorse  (and  thereby  guarantee)  this 
explicit  promise  of  the  retailer  to  pay,  and  can  sell  or  pledge  it 
with  the  bank  for  credit  to  his  own  account.  The  jobber  can  then 
draw  checks  and  remit  to  his  creditors,  and  the  bank  becomes 
debtor  to  his  creditors  until  the  checks  are  presented  for  payment. 
The  bank  looks  primarily  to  the  retailer  and  secondarily  to  the 
jobber  for  payment;  for  the  credit  of  these  two  men  it  substitutes 
its  own. 

The  third  method  is  for  the  retailer  to  borrow  at  his  bank, 
giving  his  note  for  30  days,  and  either  receive  credit  to  his  account 
against  which  he  can  check  and  pay  the  jobber,  thereby  substitut- 
ing the  bank  as  debtor  to  the  jobber  till  the  checks  are  presented; 
or  to  have  the  bank  authorize  the  jobber  to  draw  against  it 
and  agree  to  accept  the  draft  drawn  payable  in  30  days  and  to  pay 
at  maturity,  thereby  substituting  time  credit  of  the  bank  for  the 
retailer's  time  credit. 

Limitation  on  Creation  of  Deposits  of  Bank  in  System 

In  an  earlier  paragraph  it  is  stated  that  the  creation  of  deposits 
by  White  was  limited  by  the  declining  ratio  of  White's  cash  to  his 
deposits.  So  far  the  hypothesis  has  been  that  White  was  the  only 
bank  in  existence,  or  was  an  isolated  bank,  and  that  when  custom- 
ers drew  checks  against  White  and  gave  them  to  their  creditors, 
cash  to  the  amount  of  those  checks  was  withdrawn  by  the  latter 
and  stayed  out  in  circulation.  If,  however,  these  creditors  are  also 
customers  of  the  bank,  they  will  probably  deposit  the  checks  for 
credit  to  their  own  account,  in  which  case  the  process  of  payment 
amounts  to  a  transfer  of  deposits  on  the  books  of  the  bank,  and, 
inasmuch  as  no  cash  is  demanded  in  such  cases,  a  smaller  reserve 
need  be  held  by  White  as  the  proportion  of  his  customers  to  the 
whole  population  becomes  larger.    If  all  the  people  are  White's 


NATURE  OF  BANK  CREDIT  77 

customers  and  all  the  payments  in  the  community  are  made  by 
checks  on  the  bank,  it  will  need  to  keep  no  reserve  whatever, 
and  the  creation  of  deposits  through  loans  will  be  unlimited  so 
long  as  the  deposits  remain  acceptable  circulating  media.  Profits, 
too,  will  be  limited  only  by  the  demands  of  borrowers  for  loans. 

But  the  supposition  of  a  sole  or  isolated  bank  is  far  removed 
from  business  facts.  In  the  United  States  there  are  thousands  of 
banks;  many  communities  have  more  than  one  between  which 
customers  divide  their  patronage.  A  customer  of  bank  A  may 
hand  a  check  to  a  customer  of  bank  B,  who  will  deposit  it  with  B, 
and  B  will  collect  the  cash  from  A.  The  loss  of  cash  by  A  in 
meeting  such  collections  over  the  counter,  through  the  mails, 
and  at  the  clearing  house,  would  seriously  affect  the  ratio  of  cash 
to  deposits  and  endanger  the  ability  of  the  bank  to  meet  its  de- 
mand liabilities.  Now  if  one  bank,  by  the  method  of  loans  and 
discounts,  creates  an  unduly  large  sum  of  deposits,  it  is  sure  to 
suffer  adverse  clearing  house  balances,  for,  although  many  of  the 
checks  drawn  against  these  accounts  will  be  redeposited  in  the 
drawee  bank  by  holders  into  whose  hands  they  fall,  many  others 
will  be  deposited  in  other  banks  which  will  collect  cash  from  that 
bank.  Of  course,  if  all  other  banks  of  the  system  are  creating 
deposits  at  the  same  pace,  it  is  possible  that  the  checks  drawn 
against  A  and  deposited  in  banks  B,  C,  D,  and  E,  will  just  equal 
those  drawn  against  B,  C,  or  D,  respectively,  and  deposited  in  A. 
But  if  any  one  bank  creates  deposits  out  of  proportion  to  the 
others,  it  faces  the  impossibility  of  maintaining  its  cash.  For  the 
banking  system  as  a  whole  the  deposits  may  reach  a  high  multiple 
of  the  cash  reserve,  but  the  multiple  for  any  one  bank  of  the  sys- 
tem must  approximate  that  prevailing  in  other  banks. 

If  a  customer  of  A  applies  to  A  for  a  loan,  one  of  the  factors 
determining  whether  it  will  be  granted  is  the  average  daily  bal- 
ance of  his  account  with  A.  Furthermore  it  is  quite  common  for 
banks  to  insist  that  their  borrowing  customers  maintain  balances 
at  or  above  some  minimum  percentage  of  their  borrowings. 


78  MONEY,  CREDIT,  AND  BANKING 

Probably  20  per  cent  is  the  commonest  requirement;  that  is,  if  a 
loan  of  $100,000  is  extended,  the  average  daily  balance  of  the 
borrower  for  the  period  of  the  loan  must  not  be  less  than  $20,000. 
From  the  date  of  the  loan,  the  credit  is  checked  against  until 
it  reaches  some  minimum  amount;  then  a  few  days  before 
maturity  the  borrower  will  probably  build  up  his  balance  so  that 
he  may  pay  the  loan.  His  checks  drawn  during  the  loan  reach 
other  near  and  distant  banks,  which  present  them  to  A  for  pay- 
ment. The  attendant  loss  of  cash  by  A  forces  it  to  reduce  or  limit 
loans,  but  this  acquisition  of  cash  by  bank  B  makes  it  possible  for 
B  to  extend  loans.  Part  of  this  cash  will  stay  with  B,  but  the 
larger  part  will  be  drawn  out  by  bank  C  when  C  collects  checks 
against  B ;  in  turn,  C  will  extend  loans  and  B  will  retract.  By  a 
continuation  of  this  process  the  cash  will  be  widely  dispersed  and 
become  the  basis  for  successive  expansions  of  loans  and  deposits, 
but  in  smaller  and  smaller  amounts.  The  sum  of  these  deposits 
created  by  the  loans  process  and  based  upon  an  increment  of 
cash  reserve  deposited  in  some  bank  of  the  system  may  increase 
until  the  ratio  of  the  cash  to  the  new  deposits  approximates  the 
ratio  for  the  system  as  a  whole.  The  total  expansion  of  the 
system's  deposits  derived  by  the  loans  method  is  therefore  de- 
termined by  the  cash  reserve  and  the  prevailing  ratio  of  reserve 
to  deposits.  The  deposits,  however,  arising  out  of  loans  by  one 
bank  in  a  system  of  otherwise  homogeneous  banks  cannot  exceed 
the  increment  of  cash  reserve  probably  by  more  than  25  per  cent, 
because  when  such  deposits  are  created  the  borrower  proceeds 
to  check  out  all  but  a  minimum  balance  during  the  life  of  the  loan 
and  the  checks  may  be  largely  presented  through  the  clearing 
house  or  otherwise  for  payment.  Nor  can  such  deposits  be  much 
out  of  proportion  to  deposits  derived  by  other  banks  from  loans. 

Illustration  of  Need  of  Common  Ratio 

The  necessity  of  this  common  ratio  as  among  the  banks  of  a 
system  may  be  illustrated  numerically.    Assume  the  following 


NATURE  OF  BANK  CREDIT 


79 


data:  Bank  A  has  $100,000  cash  reserve,  and  likewise  all  the 
other  banks,  B,  C,  D,  and  E,  have  together,  $100,000  cash  reserve; 
bank  A  keeps  10  per  cent  reserve,  the  other  banks,  B,  C,  D,  and  E, 
keep  20  per  cent;  one-fifth  of  the  deposits  of  each  bank  is  not 
checked  out,  three-fourths  of  the  checks  are  redeposited  in  the 
drawee  bank,  and  the  rest  are  deposited  in  the  other  banks  and 
presented  through  the  clearing  house.  Then  the  situation  will  be 
as  follows: 


Bank  A 

All  Other  Banks,  B,  C,  D,  and  E 

Each 
Smaller 
Than  A 

Each 
Equal 
to  A 

Each 
Larger 
Than  A 

$    100,000 
10% 
1,000,000 
800,000 

600,000 
200,000 

$100,000 

20% 

500,000 

400,000 

300,000 
100,000 

$    400,000 

20% 

2,000,000 

1,600,000 

1 ,200,000 
400,000 

$    800,000 

Per  cent  Reserve 

Deposits 

20% 
4,000,000 
3,200,000 

2,400,000 
800,000 

Checks  Drawn 

Checks  Redeposited  in 
Drawee  Bank 

Checks  on  it  Presented 
Through    Clearing 
House 

It  is  seen  that  bank  A  suffers  an  adverse  clearing  house  bal- 
ance of  $200,000  less  $100,000,  or  $100,000,  which  wipes  out  its 
reserve.  Had  it  kept  the  same  per  cent  reserve  as  the  other  banks 
its  clearing  house  balance  would  have  been  zero.  On  the  other 
hand,  a  more  slender  reserve  would  have  resulted  in  suspension 
and  failure.  In  fact,  the  above  adverse  balance  of  $100,000  is  a 
minimum,  for  in  all  probability  some  of  the  checks  on  B  would 
have  been  deposited  in  C,  D,  or  E,  and  presented  by  them  and  not 
by  A  at  the  clearing  house.  If  the  cash  reserve  of  B,  C,  D,  and 
E  combined  had  been  assumed  to  be  less  than  $100,000,  the 
adverse  balance  of  A  would  have  been  greater. 


80  MONEY,  CREDIT,  AND  BANKING 

If,  instead  of  supposing  that  bank  A's  cash  reserve  is  equal  to 
the  total  reserve  of  banks  B,  C,  D,  and  E,  combined,  we  suppose 
that  the  reserve  of  each  bank  is  $100,000,  then  the  total  reserve 
for  B,  C,  D,  and  E  will  be  $400,000,  deposits  $2,000,000,  and 
clearing  house  items  $400,000.  One-fourth  of  $400,000,  or  $100,- 
000,  of  these  clearing  house  items  will  be  presented  against,  let 
us  say,  B.  The  banks  presenting  checks  on  B  are  A,  C,  D,  and  E, 
and,  as  it  has  been  assumed  that  they  are  all  the  same  size,  one- 
fourth  of  $100,000,  or  $25,000,  will  be  presented  by  A.  By  the 
same  reasoning  A  will  present  $25,000  against  each  of  the  other 
banks,  C,  D,  and  E,  in  the  group,  thus  presenting  a  total  of  only 
$100,000  to  be  deducted  from  the  $200,000  which  B,  C,  D,  and  E 
present  against  it.  Under  these  assumptions  it  is  evident  that  A 
would  suffer  an  adverse  clearing  house  balance  of  $100,000. 

If  instead  of  supposing  A  equal  to  B,  C,  D,  and  E,  combined, 
or  equal  to  B,  C,  D,  and  E,  severally,  A  is  assumed  to  be  smaller 
than  B,  C,  D,  and  E,  severally,  adverse  balances  will  likewise 
exist.  For  if  it  is  assumed  that  each  of  the  banks  B,  C,  D,  and 
E,  has,  say,  twice  the  cash  reserve  that  A  has,  then  the  checks  on 
B  presented  by  A,  C,  D,  and  E,  will  be  divided  somewhat  in  the 
proportions  of  1,  2,  2,  and  2;  and  one-seventh  of  $800,000,  or 
$1 14,285,  will  be  less  than  the  checks  presented  against  A.  There- 
fore, whether  bank  A  is  considered  as  smaller,  equal  to,  or  greater 
than  the  other  banks,  it  may  expect  adverse  clearing  house  bal- 
ances if  its  ratio  of  reserve  to  deposits  is  more  slender  than  that 
which  the  other  banks  of  the  system  maintain. 

This  limitation  does  not  apply  to  deposit  rights  arising  from 
the  deposit  of  cash;  it  applies  only  to  those  additional  deposits 
built  upon  cash  holdings  by  the  method  of  loan  and  discount. 
For  if  $100,000  in  cash  is  deposited,  checks  drawn  later  to  that 
amount  can  be  fully  met.  Any  one  bank  can  build  up  any  amount 
of  deposit  liabilities  by  the  cash  method,  and  proceed  to  loan  them 
all  out  except  such  a  proportion  as  business  expediency  proves 
proper  as  a  reserve.    The  adverse  clearing  house  balances  which 


NATURE  OF  BANK  CREDIT  8 1 

follow  the  loans  will  be  met  by  the  cash  that  has  been  received 
over  the  window.  Accordingly  bankers  solicit  accounts  and  offer 
various  inducements  to  get  cash  deposits  and  build  up  their 
demand  liabilities  in  that  way,  whereas  they  guard  very  care- 
fully against  overextension  of  demand  liabilities  by  the  loans 
process. 

Ratio  of  Loans  to  Deposits 

Because  a  very  large  proportion  of  deposit  liabilities  are 
created  by  the  method  of  loans  and  discounts,  and  because  re- 
ceipts of  cash  deposits  ease  the  bank's  position  and  incline  it  to 
extend  loans  to  an  amount  about  equal  to  the  cash  received,  de- 
posit liabilities  tend  to  increase  and  decrease  pari  passu  with 
loans  and  discounts  over  a  period  of  time.  Temporary  conditions 
may  obtain  in  which  deposits  of  any  one  bank  or  group  of  banks 
may  expand  faster  than  loans,  or  loans  may  even  be  decreasing. 
Instance  the  New  York  Clearing  House  banks  the  first  week  of 
April,  191 7,  when  loans  contracted  nearly  $40  million  while 
deposits  expanded  over  $86  million;  the  contraction  largely 
reflected  the  withdrawal  of  funds  from  the  time  market  in 
anticipation  of  the  Victory  Loan,  and  the  expansion  of  deposits 
represented  the  flow  of  funds  from  interior  banks  to  New  York 
for  investment  in  the  call  market.  During  1915-1916-1917, 
before  the  United  States  entered  the  war,  the  heavy  importations 
of  gold  from  abroad  created  such  an  easy  money  market  that 
bankers  found  real  difficulty  in  loaning  funds  as  fast  as  they  came 
from  depositors.  On  the  other  hand,  loans  may  increase  faster 
than  deposits,  and  then  the  money  market  will  tighten. 

The  history  of  the  ratio  of  loans  to  deposits  in  the  New  York 
Clearing  House  banks  is  shown  by  Figure  1 .  It  will  be  noted  that 
at  times  of  crises  the  ratio  of  loans  to  deposits  runs  high  (instance 
the  autumns  of  1904  and  1907,  the  midsummer  of  1914,  and  the 
latter  part  of  191 7)  and  then  falls  precipitately  as  contraction 
develops. 


82 


MONEY,  CREDIT,  AND  BANKING 


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NATURE  OF  BANK  CREDIT  83 

Bank  Notes 

White's  last  two  statements  (see  page  73  above)  of  assets  and 
liabilities  showed  the  alternative  effects  of  his  paying  for  dis- 
counts with  cash  or  deposits;  the  two  previous  statements  showed 
the  similar  alternative  effects  of  his  making  loans  in  cash  or  de- 
posits; and  the  first  statement  showed  deposits  arising  by  the 
deposit  of  cash  or  cash  items.  Another  alternative  was  open  to 
White  in  each  case.  Instead  of  paying  cash  or  crediting  deposits 
to  be  drawn  later  by  order,  White  might  have  paid  by  simple 
promissory  demand  notes  payable  to  bearer.  These  notes  would 
be  in  small  denominations,  round  amounts,  and  convenient  size, 
and,  if  White  was  well-reputed,  would  be  readily  accepted  by 
others  and  would  tend  to  circulate  as  money.  If  the  proceeds 
of  the  $35,000  of  discounts  had  been  paid  in  bank  notes,  the 
financial  statement  in  this  case,  starting  with  the  figures  given 
in  the  last  statement  on  page  73,  would  have  been  as  follows: 

Assets  Liabilities 

Cash $100,000      Deposits $145,000 

Loans  and  Discounts . . .         80,000      Bank  Notes  Outstanding       34,000 

Discount 1 ,000 

Obviously  many  variations  may  be  introduced  here  to  indicate 
part  payments  of  loans,  discounts,  collections,  and  so  forth,  in 
cash,  deposits,  and  bank  notes.  For  instance,  items  to  the 
amount  of  $27,000  may  be  discounted  and  the  proceeds,  $25,000, 
be  paid,  one-fifth  in  cash,  two-fifths  in  bank  notes,  and  the  rest 
credited  as  deposits,  with  the  following  results  on  the  last  state- 
ment: 

Assets  Liabilities 

Cash $95,000      Deposits $155,000 

Loans  and  Discounts .. .       107,000      Bank  Notes  Outstanding        44,000 

Discount 3 ,000 


84  MONEY,  CREDIT,  AND  BANKING 

Summary — The  Three  Functions  of  Commercial  Banking 

The  three  fundamental  functions  of  commercial  banking  are, 
then,  discount,  deposits,  and  note  issue;  discount  (and  loan)  is, 
in  practice,  but  one  method  of  creating  deposits  and  note  issue; 
and  the  three  functions  readily  reduce  themselves  to  one,  namely, 
the  guaranty  of  the  credit  of  individuals.  The  guaranty  is 
effected  by  a  highly  developed,  specialized,  and  well-known  in- 
stitution, holding  a  liquid  cash  reserve,  as  well  as  quickly  con- 
vertible assets,  and  standing  ready  to  exchange  its  own  credits  for 
those  of  customers. 

Capital 

In  the  discussion  in  the  previous  sections,  White  has  been 
doing  business  entirely  on  his  customers'  money  and  his  own 
credit.  No  mention  has  been  made  of  any  direct  contribution  of 
funds  by  himself;  he  started  with  a  deposit  transfer  business,  and 
later  developed  a  loan  and  discount  business  and  a  bank  note 
issue  business.  Undoubtedly  any  person  who  deposited  money 
directly  with  White,  or  who  borrowed  from  or  sold  discounts  to 
White  and  left  the  proceeds  on  deposit  with  him,  or  took  his  notes 
in  payment,  that  is,  any  person  who  became  his  creditor,  would 
more  readily  become  creditor  if  White  himself  were  willing  to  put 
up  a  guaranty  fund  and  thus  increase  the  assets  out  of  which  the 
creditor  could  recover.  Such  contributions  by  A  are  generally 
made  from  the  very  start;  they  give  confidence  to  would-be 
creditors  that  he  will  be  willing  and  able  to  repay  and  make  good 
his  promises,  and,  of  course,  the  greater  such  contributions  the 
greater  the  security  to  the  creditors,  for  they  can  collect,  not  only 
against  the  assets  procured  by  White  through  their  own  cash  de- 
posits, but  also  against  the  assets  procured  by  White  through  his 
own  contributions. 

Such  original  contributions  are  called  "capital."  White  usu- 
ally associates  with  himself  other  persons  who  likewise  contribute 
capital.    Ownership  of  the  assets  of  the  association  is  then  in  pro- 


NATURE  OF  BANK  CREDIT  85 

portion  to  the  contributions;  profits,  losses,  and  responsibilities 
are  proportioned  upon  the  same  basis.  The  association  may  be 
incorporated  under  the  laws  of  the  state  and  capitalized  at,  say, 
$100,000,  the  capital  contributions  and  ownership  being  evi- 
denced by  $100  shares  of  capital  stock.  Subscriptions  (contri- 
butions) to  the  capital  stock  may  be  in  cash,  real  estate,  securities, 
promissory  notes,  or  other  assets.  If  the  subscription  is  paid  in 
cash,  some  of  it  would  be  immediately  invested  in  a  bank  building, 
furniture,  and  fixtures,  and  the  rest  of  it,  along  with  funds  de- 
posited by  depositors,  gradually  absorbed  in  investments,  loans, 
and  discounts,  real  estate,  cash  reserve,  and  so  forth. 

As  a  result  of  all  this  White  has  now  become  a  full-fledged 
banking  company. 

Surplus  and  Undivided  Profits 

The  company  may,  voluntarily  or  by  force  of  law,  over  a  pe- 
riod of  years  add  to  the  original  capital  contributions  by  with- 
holding part  of  its  earnings,  not  declaring  them  in  dividends  and 
converting  them  into  a  "surplus"  fund.  The  state  law,  as  a  pro- 
tection to  the  bank's  creditors  and  as  a  means  of  adding  to  the 
stability  of  financial  institutions,  may  require  that  the  bank  ac- 
cumulate a  surplus  equal  to,  say,  40  per  cent  of  its  capital  and 
that  a  certain  fraction  of  the  yearly  earnings  be  diverted  to  that 
fund  until  it  is  filled.  To  make  their  bank's  statement  somewhat 
more  comparable  to  those  of  other  institutions,  and  also  to  reduce 
the  extra  liability  that  may  attach  to  stock  ownership,  the 
founders  of  the  bank  may  start  with  a  capital  of  $100,000  and  a 
surplus  of  $100,000  rather  than  with  a  capital  of  $200,000.  The 
surplus  accumulated  in  an  old  bank  may  be  many  times  its  capital. 

Public  policy  requires  that  capitalization  bear  a  rough  propor- 
tion to  the  size  of  the  business  done;  and,  since  size  of  business 
is  roughly  proportional  to  the  population  of  the  domiciling  city, 
the  state  and  federal  laws  have  fixed  the  minimum  capitalization 
of  banks  in  various  sized  cities. 


86  MONEY,  CREDIT,  AND  BANKING 

The  existence  of  a  fair-sized  surplus  also  promotes  stability 
in  corporate  control.  If  in  bad  years  net  operating  deficits  had 
to  be  met  by  assessing  the  stockholders  rather  than  by  using 
up  the  surplus,  the  wealthy  stockholders  would  be  at  an  ad- 
vantage over  the  poorer,  who  would  find  it  difficult  to  meet  the 
assessments.  In  fact  the  corporation  might  fall  into  the  con- 
trol of  unscrupulous  men  who  would  purposely  operate  it  at  a 
deficit  in  order  to  "freeze  out"  the  weak  stockholders.  This 
operation,  however,  is  less  likely  to  succeed  if  a  large  surplus 
must  be  exhausted  before  assessments  can  be  put  on  stockholders. 

To  maintain  a  working  balance,  the  bank  does  not  declare  all 
its  earnings  as  dividends  nor  convert  them  into  surplus,  but  re- 
tains a  relatively  small  amount  as  "undivided  profits."  The 
capital,  surplus,  and  undivided  profits  represent  the  original  and 
accumulated  contributions  of  the  owners  of  the  bank,  and  serve 
as  a  buffer  to  reinforce  the  claims  of  the  bank's  creditors.  These 
contributions,  along  with  the  funds  contributed  by  creditors,  are 
invested  in  various  assets,  only  a  small  part  of  which  is  held  as 
cash  reserve. 

It  is  wholly  wrong  to  think  that  surplus  and  undivided  profits 
constitute  a  fund  of  cash  in  the  bank,  or  any  other  particular 
form  of  assets.  The  surplus  together  with  the  undivided  profits 
is  a  property  right  (in  proportion  to  the  shares  owned)  of  the 
stockholders  in  the  general  assets,  and  as  such  is  a  valuation  item 
in  the  financial  statement.  The  accumulated  aggregate  assets 
have  a  book  valuation  more  or  less  equal  to  the  market  valuation. 
This  book  valuation,  less  the  creditor  liabilities  and  the  capitaliza- 
tion, is  the  surplus.  If  the  book  valuation  exceeds  the  market 
valuation,  the  surplus  is  not  substantial;  on  the  other  hand,  if  the 
assets  are  undervalued,  the  bank  creditors  have  more  protection 
than  is  shown.  Capital  and  surplus  protect  depositors  and  note- 
holders, for  in  case  of  liquidation  the  greater  the  actual  value  of 
the  assets  belonging  to  stockholders  the  more  are  the  funds  that 
can  be  realized  for  the  bank's  creditors. 


CHAPTER  VI 
BANK  OPERATIONS  AND  FUNCTIONS 

Fundamental  and  Other  Functions 

The  activities  described  in  the  preceding  chapter  as  discount, 
deposit,  and  note  issue  are  traditionally  called  the  fundamental 
functions  of  commercial  banks.  "Function"  here  means  the 
course  of  action  which  peculiarly  pertains  to  or  is  appropriate  to 
the  institution.  The  operations  of  discount,  deposit,  and  issue 
have  been  shown  to  be  reducible  to  a  guaranty  of  private  credit 
or  to  a  substitution  of  bank  credit  for  private  credit.  These 
operations  are  not,  of  course,  ends  in  themselves,  but  activities 
toward  accomplishing  ends.  Some  recent  writers  on  banking 
call  these  immediate  activities  banking  "operations"  and  their 
ends,  banking  "functions."  Although  in  the  further  analysis  of 
causation  these  so-called  "functions"  will  be  but  "operations" 
to  even  more  remote  ends,  it  may  be  well  to  consider  the  activities 
so  distinguished  as  functions. 

In  the  other  volumes  of  this  book  many  other  banking  opera- 
tions than  discount,  deposit,  and  issue  will  be  described.  Some 
of  them  have  become  traditionally  associated  with  banks  and  are 
peculiarly  appropriate  to  them.  Banks  could  not  continue  in 
business  unless  they  performed  a  wide  variety  of  operations  which 
competition  has  forced  them  to  assume.  These  operations  are 
usually  incidental  to  discount,  deposit,  and  issue,  and  are  per- 
formed for  borrowers  or  depositors  and  in  consideration  of  their 
accounts.  Other  activities  may  be  undertaken  by  a  bank  because 
it  has  an  organization  that  can  assume  and  execute  the  additional 
duties  more  economically  than  specialized  organizations  could  do. 
Some  of  these  activities  may  produce  no  small  part  of  the  bank's 
earnings  and  therefore  seem  quite  essential;  others  are  purely 

87 


88  MONEY,  CREDIT,  AND  BANKING 

adventitious  and  occasion  a  large  net  expense,  but  are  undertaken 
for  the  indirect  benefits  that  accrue  from  general  publicity. 

Banks  as  Credit  Markets 

Banking  operations  facilitate  the  production  and  distribution 
of  goods.  They  do  this  by  organizing  the  market  for  credit,  by 
negotiating  between  lender  and  borrower,  by  rendering  an  ever 
larger  volume  of  our  collective  wealth  into  "bankable "  form  and 
promoting,  not  only  its  transferability  but  also  its  actual  transfer 
to  the  most  effective  uses.  The  lender  repairs  to  the  bank  to 
deposit  (lend,  invest)  his  surplus,  the  borrower  goes  there  to  find 
accommodation;  the  bank  is  the  organized  credit  mart.  As  a 
basis  of  credit  the  banker  increasingly  accepts  stocks,  bonds, 
mortgages,  bills  of  lading,  warehouse  receipts,  and  other  property 
rights  in  wealth  that  is  not  itself  available  as  a  basis  of  credit; 
possession  of  such  titles  can  in  this  way  be  made  the  means  of 
procuring  bank  funds,  purchasing  power,  and  finally  control  over 
other  wealth  useful  in  production  and  distribution.  The  banker 
determines  largely  the  personnel  of  the  business  world;  he  is  a 
shrewd  judge  of  ability  to  produce  and  distribute  efficiently;  he 
seeks  as  customers  those  who  by  their  financial  record  and  original- 
ity, aggressiveness  and  opportunity,  promise  well,  and  he  dis- 
courages the  opposite  sort  of  applicant. 

The  American  tradition  holds  that  commercial  banks  should 
finance  only  short-term,  self-liquidated  transactions  and  should 
leave  the  provision  of  permanent  capital  to  specialized  invest- 
ment institutions.  The  theory  is  that,  since  the  liabilities  of  the 
bank  are  demand  liabilities,  the  assets  must  largely  consist  of  cash, 
and  that  short-term,  self-liquidating  paper  is  the  most  convertible 
and  manageable  earning  asset.  This  traditional  theory  bears  the 
approval  of  state  and  federal  law,  and  the  banking  system  con- 
forms nominally  to  the  theory;  but  an  examination  of  the  busi- 
ness (banking  and  investment)  situation  reveals  the  following 
facts: 


BANK  OPERATIONS  AND  FUNCTIONS         89 

1.  No  small  part  of  commercial  loans  are  provisions  of  per- 
manent investment  capital. 

2.  Industrial  loans  which  finance  the  purchase  of  raw  ma- 
terials and  labor  to  make  a  marketable  product  are  quite  as 
good  bank  assets  as  commercial  loans  to  finance  the  marketing 
processes. 

3.  The  so-called  self -liquidating  loans  are  largely  liquid  only 
with  respect  to  individual  banks  and  not  to  the  banking  system 
as  a  whole. 

4.  Liquidity  is  mainly  a  matter  of  high  organization  of  the 
market  for  credits  and  of  the  markets  for  the  various  forms  of 
collateral. 

Extensions  of  Investment  Credit 

To  the  degree  that  banks  invest  in  stocks  and  bonds  of  cor- 
porations, they  contribute  fixed  capital  to  enterprises.  The 
purchase  of  securities  is  the  practical  equivalent  of  loaning  funds; 
loans  to  purchase  securities  which  are  then  pledged  to  secure  the 
loans  are  practically  vicarious  purchases  of  the  securities.  That 
there  is  a  marked  tendency  for  commercial  loans  to  become  con- 
tinuous and  permanent  is  due  to  the  fact  that  production  tends  to 
become  more  and  more  capitalistic  and  continuous  operation 
more  and  more  necessary  for  efficiency,  while  improved  facilities 
in  distributing  products  lengthen  the  period  of  consumption  and 
reduce  the  seasonal  feature  of  business.  Probably  a  fifth  of  com- 
mercial bank  loans  are  now  for  investment  purposes. 

The  one-time  practice  of  banks  of  insisting  that  their 
borrowers  "clean  up"  their  loan  account  at  least  once  a  year  has 
nearly  ceased,  except  in  lines  of  business  having  one  or  two  definite 
seasons,  and  loans  are  indefinitely  renewed  time  after  time,  or  if 
borrQwers  are  required  to  "clean  up"  they  may  borrow  at  one 
bank  to  "  clean  up  "  at  another.  Large  borrowers  sell  their  notes 
widely  over  the  country  through  note-brokers;  to  pay  a  lot  of 
notes  maturing  and  due  to  holders  in  one  section  of  the  country, 


90  MONEY,  CREDIT,  AND  BANKING 

another  lot  will  be  issued  and  sold  either  to  these  same  holders  or 
to  purchasers  in  other  sections;  thus  the  banking  system  as  a 
whole  supplies  permanent  working  capital.  The  individual  bank, 
however,  may  decline  to  renew  a  loan  or  to  purchase  the  renewal 
paper,  and  thus  not  itself  provide  permanent  capital. 

When  the  whole  banking  system  is  considered,  it  is  clear  that 
commercial  paper  is  only  to  a  small  extent  self-liquidating.  The 
banks  renew  loans  freely,  as  just  noted;  their  regular  customers 
depend  upon  this  accommodation,  and  large  contraction  or  re- 
fusal to  renew  loans  is  quite  impossible,  especially  in  time  of 
panic.  When  a  borrower  becomes  strong  enough  to  borrow 
through  sale  of  his  paper  widely  over  the  country  and  any  holder 
refuses  to  purchase  the  renewal  paper,  he  can  borrow  from  other 
banks.  The  holder  bank  may  also  at  any  time  sell  the  paper  to 
another  bank.  Thus  rediscount  gives  liquidity,  but  rediscount  is 
simply  a  shifting  of  assets  as  between  banks  and  as  between  forms 
of  assets.  One  of  the  specific  purposes  in  developing  the  federal 
reserve  banks  was  that  of  providing  central  banks  where  paper 
holdings  of  needy  banks  might  be  converted  into  cash  funds  by 
this  process  of  shifting  assets.  The  capacity  of  the  federal  reserve 
banks  to  liquefy  by  rediscounting  comes  through  their  ability  to 
tap  unused  reserves  and  to  create  federal  reserve  notes,  which 
in  the  tills  of  the  banks  constitute  not  only  a  paying  medium  but 
also  an  actual  reserve,  although  not  termed  "reserve"  by  the 
law. 

Loan  Ratios  as  Business  Barometers 

The  sum  of  a  bank's  investments  in  securities  and  of  its  loans 
and  discounts  represents  its  contributions  of  capital  to  business. 
A  part  of  these  funds  was  originally  deposited  as  cash  in  the  bank; 
the  rest  have  been  created  by  the  bank.  Bank  notes  and  deposit 
liabilities  have  been  created  and  exchanged  by  the  bank  for 
various  credit  items  of  borrowers,  while  the  borrowers  possessing 
these  bank  notes,  deposits,  or  actual  government  money,  have 


BANK  OPERATIONS  AND  FUNCTIONS 


91 


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92  MONEY,  CREDIT,  AND  BANKING 

been  enabled  to  procure  materials,  labor,  tools,  plant,  transporta- 
tion, and  the  like.  The  funds  put  into  investments  and  some  in- 
determinate proportion  of  the  loans  (and  discounts)  represent 
contributions  of  permanent  capital.  The  proportion  of  the  loans 
which  constitutes  permanent  advances  of  capital  ranges  in  all 
probability  from  20  to  50  per  cent.  The  tendency  is  to  increase. 
The  ratio  of  cash  reserve  to  investments,  plus,  say,  30  per 
cent  of  loans,  is  therefore  a  measure  of  the  degree  to  which  a  bank 
contributes  permanent  capital  to  business.  The  ratio  of  cash 
reserve  to,  say,  70  per  cent  of  loans,  measures  the  temporary 
advances.  Users  of  business  barometers  watch  closely  the  less 
complex  ratios  of:  (1)  cash  reserve  to  loans,  (2)  investments  to 
aggregate  assets,  (3)  loans  to  aggregate  assets,  and  (4)  the  sum 
of  loans  and  investments  to  aggregate  assets.  The  history  of  the 
first,  third,  and  fourth  ratios  is  shown  in  the  accompanying  charts 
(Figures  2  and  3),  and  by  subtracting  the  third  from  the  fourth  the 
second  can  be  obtained.  During  the  war  the  increase  of  bank 
cash  reserves  in  this  country  did  not  keep  abreast  of  the  expansion 
of  loans,  the  result  being  that  the  ratio  of  cash  reserves  to  loans 
decreased  precipitately.  The  loan  account  developed  into  an 
unprecedented  state  of  extension;  the  banks  met  the  urgent  de- 
mands for  funds  to  finance  the  war  and  war  industries;  an  ex- 
cessive proportion  of  the  loans  was  collateraled  by  United  States 
securities,  and  did  not  necessarily  represent  contributions  of 
working  capital  to  industries.  The  percentage  increase  of  securi- 
ties, largely  United  States  war  securities,  purchased  by  the  banks 
rose  faster  than  the  percentage  increase  of  either  loans  or  aggre- 
gate assets.  As  the  purchase  of  securities  is  from  the  bank's 
point  of  view  in  many  respects  equivalent  to  a  loan  to  the  seller, 
these  large  purchases  during  the  war  had  the  effect  of  increasing 
the  multiple  to  which  banks  create  a  loan  fund  on  the  basis  of 
cash  reserve.  It  might  be  said  also  that  the  contributions  of  per- 
manent capital  by  banks  were  in  effect  increased  both  absolutely 
and  relatively.     Some  liquidity  was  given  to  the  war  loans  by 


BANK  OPERATIONS  AND  FUNCTIONS 


93 


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MONEY,  CREDIT,  AND  BANKING 


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BANK  OPERATIONS  AND  FUNCTIONS  95 

making  paper  backed  by  war  securities  eligible  for  discount  with 
the  federal  reserve  banks. 

To  put  some  fraction  of  a  bank's  funds  into  permanent  invest- 
ments is  altogether  safe  and  fitting,  for  in  emergency  they  can  be 
readily  converted  into  cash  through  the  stock  exchange.  Ex- 
tensive dependence  of  all  the  banks  on  the  securities  market  for 
such  conversion,  however,  becomes  positively  dangerous.  In 
order  to  accomplish  a  sale  in  a  tight  money  market,  not  only  must 
securities  be  sacrificed  at  great  losses  but  the  buyers  go  to  other 
banks  to  withdraw  funds  to  do  the  buying,  thus  making  the 
market  still  tighter  and  tending  to  precipitate  a  panic.  Accord- 
ingly the  business  world  takes  note  of  the  ratios  of  loans  and 
investments  to  total  resources.  The  banking  situation  of  the  coun- 
try becomes  more  critical  as  the  proportion  of  loans  to  aggregate 
resources  increases,  because  such  a  change  means  an  absorption 
of  the  loan  fund;  and  it  becomes  even  more  critical  as  the  ratio  of 
investments  to  aggregate  resources  increases,  for  the  additional 
reason  that  a  larger  proportion  of  banking  funds  is  being  tied  up 
in  long-term  securities  which  are  difficult  to  liquefy.  Babson 
summarizes  the  barometrics  of  these  ratios  as  follows:1 

i.  During  a  period  of  business  depression: 

(a)  An  increase  in  the  ratio  signifies  renewed  activity. 

(b)  A  decrease  signifies  a  further  recession  in  business. 

(c)  No  change  signifies  continued  dullness. 

2.  During  a  period  of  improvement  following  a  period  of  business 

depression: 

(a)  An  increase  in  the  ratio  signifies  increased  activity. 

(b)  A  decrease  signifies  a  temporary  recession. 

(c)  No  change  calls  for  special  watchfulness. 

3.  During  a  period  of  prosperity: 

(a)  An  increase  in  the  ratio  signifies  that  fundamental  con- 

ditions are  becoming  unsound. 

(b)  A  decrease  tends  to  prolong  the  period  of  prosperity. 

(c)  No  change  signifies  nothing  of  importance. 


1  Babson,  R.  W..  Business  Barometrics.  1918,  p.  272. 


96  MONEY,  CREDIT,  AND  BANKING 

4.  During  a  period  of  decline  following  a  period  of  prosperity: 

(a)  An  increase  in  the  ratio  signifies  further  trouble. 

(b)  A  decrease  is  the  natural  movement. 

(c)  No  change  calls  for  special  watchfulness. 

Effect  of  Other  Operations  on  the  Bank  Statement 

So  far  as  developed  in  the  preceding  sections,  the  operations 
of  White,  the  bank,  might  result  in  a  capital  statement  such  as 
the  following: 

Assets  «  Liabilities 

Loans  and  Discounts $304,395        Capital $100,000 

Cash:  Surplus 50,000 

Gold     and     Silver  Undivided  Profits 10,323 

Dollars $22,104  Deposits 218,442 

Government    Paper  Bank  Notes  Outstanding 20,000 

Money 3, 033 

Subsidiary  Silver. . .  273 

Minor  Coins 15         25,425 

Investments 68,945 


$398,765  $398,765 


It  is  now  proposed  to  explain  certain  other  simple  but  typical 
operations,  and  indicate  their  effects  upon  the  bank's  statement. 

The  accounts  entitled  "Due  from  Banks"  and  "Due  to 
Banks  "  arise  because  the  bank  finds  it  expedient  to  open  accounts 
with  other  banks,  and  to  deposit  certain  of  its  funds  with  them. 
These  depository  banks  are  called  "correspondents."  Such  ac- 
counts serve  among  others  the  following  purposes: 

1.  They  enable  the  bank  to  sell  drafts  against  this  distant 
metropolitan  correspondent  and  charge  exchange  for  the  service. 

2.  The  banks  may  arrange  mutually  to  act  as  collecting  agent 
one  for  the  other,  and  possibly  charge  for  the  service. 

3.  In  time  of  stress  the  local  bank  can  count  on  accommoda- 
tion from  the  metropolitan  correspondent. 

4.  The  correspondent  may  furnish  special  services  for  the 
local  bank,  such  as  credit  advice,  investment  of  funds,  safe-keep- 


BANK  OPERATIONS  AND  FUNCTIONS  97 

ing  of  securities,  and  the  like.  The  local  bank  may  in  turn  carry- 
accounts  of  banks  for  which  it  acts  as  correspondent. 

Whenever  a  statement  of  the  bank  is  made,  therefore,  among 
the  assets  will  appear  Due  from  Banks,  and  among  the  liabilities 
Due  to  Banks. 

If  a  draft  is  sold  by  the  local  bank,  the  Due  from  Banks  is 
reduced  by  the  face  amount  of  the  draft.  Undivided  Profits  is 
increased  by  the  charge  for  exchange,  and,  if  the  face  of  the  draft 
and  the  exchange  charge  are  paid  in  cash,  Cash  will  be  increased 
by  these  amounts.  If,  however,  the  buyer  of  the  draft  pays  by 
check  on  the  selling  bank,  Deposits  is  reduced,  and  if  by  check  on 
other  banks,  Due  from  Banks  is  increased. 

When  items  are  received  for  collection  and  credit,  the  local 
bank  credits  the  remitter's  (or  depositor's)  account  with  the  face 
amount  of  the  items — that  is,  credits  Deposits  and  carries  items 
among  the  assets  as  Collection  Items  in  process  of  collection; 
when  collected,  either  Cash  or  Due  from  Banks  is  increased. 
Checks  on  local  clearing  house  banks  are  usually  separated  from 
checks  on  out-of-town  banks  and  are  reported  as  Clearing  House 
Items. 

The  purchase  of  a  site,  a  building,  furniture,  and  fixtures, 
reduces  the  bank's  Cash  or  its  balances  Due  from  Banks.  Such 
payments  by  the  bank  are  usually  made  by  cashier's  checks  or 
drafts;  while  these  checks  are  outstanding  they  appear  among 
the  liabilities,  and  when  they  are  presented  for  payment,  Cash 
will  be  reduced. 

Stationery,  wages,  salaries,  rent,  taxes,  and  so  forth  are  ex- 
pense items  that  will  likewise  be  paid  by  cashier's  checks. 
Temporarily  they  will  appear  as  Expense  among  the  assets  and 
Cashier's  Checks  among  the  liabilities;  the  ultimate  disposition 
will  be  the  reduction  of  Cash  by  payment  of  the  checks  and  the 
reduction  of  the  Undivided  Profits. 

Customers  may  deposit  cash  funds  and  take  certificates  of 
deposit,   which  will   thereafter  appear  among  the   liabilities. 

VOL.  I — 7 


98  MONEY,  CREDIT,  AND  BANKING 

These  certificates  state  that  the  customer  deposited  a  certain 
amount  on  a  given  date,  which  will  be  repaid  to  him  with  inter- 
est at  a  stated  rate  provided  payment  is  not  demanded  within 
a  stipulated  time. 

If  a  depositor  overdraws  his  account,  the  drawee  bank  may 
exercise  its  discretion  at  paying  the  amount.  If  allowed  the 
drawer's  account  (his  Deposits)  is  wiped  out,  and  the  bank  has 
a  presumptive  claim  against  the  drawer  for  the  deficit,  which 
it  lists  among  its  assets  as  Overdrafts.  Cash  is  reduced  by  the 
face  amount.  If  this  check  had  been  presented  through  a  cor- 
respondent bank  the  Due  from  Banks  would  be  reduced  by  the 
face  amount. 

In  the  case  of  the  issue  of  bank  notes  by  a  national  bank,  the 
issuing  bank  must  first  buy  or  borrow  United  States  bonds  to 
pledge  with  the  United  States  Treasury  as  security;  this  re- 
duces Cash  and  increases  Investments,  or  else  puts  among  the 
liabilities  Bonds  Borrowed  and  adds  to  Investments.  The 
National  Bank  Law  requires  that  a  redemption  fund  of  5  per 
cent  of  the  notes  issued  also  be  kept  in  gold  at  Washington;  this 
reduces  Cash  but  adds  a  new  item,  Redemption  Fund,  to  the 
assets.  The  bank  notes  come  to  the  paying  teller,  and  he  puts 
them  into  the  Cash  of  the  bank,  and  an  equivalent  liability, 
Bank  Notes  Outstanding,  appears  in  the  statement.  Whenever 
any  of  the  notes  are  presented  to  the  bank  for  redemption,  Cash 
in  the  statement  is  unaffected,  for  one  form  of  cash  is  simply  sub- 
stituted for  another;  but  when  presented  at  Washington  for  re- 
demption, the  Redemption  Fund  is  reduced  and  Bank  Notes 
Outstanding  is  also  reduced. 

If  Undivided  Profits  becomes  large,  the  directors  may  decide 
to  increase  Surplus  and  declare  dividends.  Then  Undivided 
Profits  will  be  reduced  at  once  by  the  amount  put  into  surplus 
and  dividends;  the  dividends  will  be  carried  temporarily  as  Div- 
idends Declared  but  Unpaid;  when  paid,  this  item  will  dis- 
appear and  Cash  be  reduced. 


BANK  OPERATIONS  AND  FUNCTIONS  99 

If  the  book  values  of  certain  assets  are  found  too  high,  because 
they  were  originally  overvalued  or  have  meanwhile  depreciated 
or  have  proved  uncollectible,  and  it  is  necessary  to  scale  down 
the  valuations,  the  asset,  Investments,  or  Loans  and  Discounts, 
or  Real  Estate,  Buildings,  Fixtures,  or  whatever  asset  it  may  be,  is 
reduced,  and  Undivided  Profits  is  reduced  a  like  amount. 

The  local  bank  may  be  pressed  for  funds,  and  be  forced  to 
borrow  from  its  correspondent  on  the  basis  of  its  promissory  note 
secured  by  discount  paper  from  its  note  pouch.  Its  Cash  and 
Due  from  Banks  will  be  increased  and  Bills  Payable  will  then 
appear  among  its  liabilities. 

The  bank  may  issue  letters  of  credit  by  which  it  agrees  to 
accept  certain  drafts  or  bills  of  exchange  drawn  upon  it.  Later 
when  these  are  presented  for  acceptance,  the  bank  will  incur 
specific  liability  for  Acceptances.  These  liabilities  are  equalized 
by  the  introduction  of  the  corresponding  assets,  Customers' 
Liability  Under  Letters  of  Credit,  and  Customers'  Liability  for 
Acceptances  Executed.  The  nature  of  these  operations  will  be 
detailed  in  a  later  chapter  (see  Volume  V,  Chapter  LXI. 

Typical  Bank  Statement 

The  combined  effect  of  these  and  other  transactions  is  to 
render  the  statement  into  that  of  a  typical  commercial  bank. 

There  is,  however,  no  uniformity  of  style  or  titles  in  the 
published  statements,  whether  of  the  same  or  different  classes 
of  banks.  Uniform  accounting  is  somewhat  promoted  by  gov- 
ernment supervision  of  banks  and  the  requirement  of  periodic 
reports.  Nevertheless  in  the  publication  of  their  financial 
statements  wide  variation  occurs  because  bankers  have  different 
conceptions  of  what  constitutes  a  good  report,  because  the 
statements  are  adapted  to  different  clienteles,  and  because  the 
bankers  have  different  motives  to  serve.  These  purposes  are 
attained  by  combining  items  under  varying  heads.  The  fol- 
lowing is  a  typical  statement  of  a  small  bank. 


100 


MONEY,  CREDIT,  AND  BANKING 


Assets 

Loans  and  Discounts $    458,426 

Cash 44.975 

Investments 95. 000 

Real  Estate  and  Bank  Building  2 1 ,000 

Furniture  and  Fixtures 5.000 

Expense 1,252 

Bonds  Loaned 10,000 

Collection  Items 35.000 

Clearing  House  Items 78,000 

Redemption  Fund 2,300 

Overdrafts 4.621 

Due  from  Banks 165,000 

Customers'     Liability     Under 

Letters  of  Credit 95.000 

Customers'   Liability  for  Ac- 
ceptances Executed 80,000 

Other  Assets 7.396 

$1,102,970 


Liabilities 

Capital $     100,000 

Surplus 75,000 

Undivided  Profits 16,312 

Dividends   Declared  but  Un- 
paid   4,000 

Bonds  Borrowed 20,000 

Deposits 487,345 

Cashier's  Checks 45,000 

Bank  Notes  Outstanding 40,000 

Certificates  of  Deposit 55, 000 

Acceptances 80,000 

Due  to  Banks 48,000 

Letters  of  Credit 95,000 

Bills  Payable 20,000 

Reserved  for  Taxes,  Insurance  6,000 

Other  Liabilities 1 1,323 


$1,102,970 


Clearings  and  Collections 

In  the  process  of  executing  the  functions  of  loan,  discount, 
deposit,  and  note  issue,  and  of  the  incidental  business  of  the  bank, 
there  come  into  its  possession  numerous  forms  of  credit  items 
which  must  be  presented  to  the  respective  debtors  for  payment. 
Preliminary,  however,  to  a  discussion  of  the  various  operations 
performed  by  a  bank  with  this  end  in  view,  involving  as  it  would 
an  explanation  of  clearing  house  procedure  and  out-of-town 
collection  methods,  consideration  should  be  given  to  the  factors 
that  determine  when  a  credit  instrument  will  be  presented  for 
payment. 

There  are  various  factors  which  determine  when  a  credit 
instrument  will  be  presented  for  payment.  These  include  the 
question  whether  the  item  has  a  fixed  maturity,  whether  it  bears 
interest,  whether  it  can  be  used  as  a  medium  of  exchange  or  as 
bank  reserve,  and  whether  the  law  requires  presentment  within  a 
certain  time. 

Of  the  four  common  forms  of  bank  liabilities  to  creditors,  the 
first  two — Bank  Notes  and  Deposits — are  generally  payable  on 
demand  and  do  not  bear  interest,  whereas  the  other  two  forms — 


BANK  OPERATIONS  AND  FUNCTIONS  IOI 

Bills  Payable  and  Acceptances — are  payable  at  a  time  fixed  by  the 
date  of  acceptance  and  the  terms  of  the  papers  and  may  or  may 
not  bear  interest.  As  a  check  cannot  be  readily  used  by  the  payee 
in  making  payments  or  for  reserves  and  does  not  bear  interest, 
the  holder  has  funds  which  are  useless,  and  at  the  same  time  he 
incurs  a  certain  risk  that  the  check  will  not  be  honored.  In  addi- 
tion the  statutory  or  common  law  may  require  him  to  present  the 
item  for  payment  within  a  certain  time.  Bank  notes,  on  the 
other  hand,  attain  to  general  acceptability  because  the  holder 
may  make  payments  with  them  and  one  bank  may  use  the  notes 
of  other  banks  as  reserves.  If  the  law  were  to  prohibit  such  uses, 
bank  notes  would  be  collected  at  once  upon  receipt,  just  as  checks 
are;  otherwise  the  holder  would  lose  the  use  of  the  funds  repre- 
sented and  the  debtor  would  have  them  meanwhile  without 
having  to  pay  interest.  Acceptances  and  bills  payable  having  a 
definite  maturity  must  be  presented  for  payment  at  the  time  of 
maturity.  If  interest  ceases  at  maturity  it  is  financially  profit- 
able to  present  the  item  at  that  time  and  the  law  may  also 
require  such  presentation  so  as  to  protect  the  indorsers  of  the 
instrument. 

Methods  of  Presentment 

The  method  of  presentment  of  an  item  for  payment  is  deter- 
mined by  its  cost  and  by  legal  requirements.  The  costs  include 
the  clerical  work,  messenger  service,  loss  of  interest  on  idle  funds, 
risks  of  carrying  the  items  or  moneys  in  the  street  or  in  the  mails, 
and  so  forth.  Items  on  institutions  in  the  holder's  city  are  col- 
lected either  by  messenger  or  through  the  clearing  house.  A 
clearing  house  is  now  established  in  every  city  of  considerable 
size  and  the  items  collected  by  messenger  include  merely  those  on 
institutions  not  members  of  the  clearing  house,  documentary 
items,  special  advice  items,  and  large  sight  items.  At  the  bank 
the  city  collection  clerk  dispatches  messengers  over  prescribed 
routes  with  these  collection  items. 


102 


MONEY,  CREDIT,  AND  BANKING 


The  Clearing  House 

The  clearing  house  is  an  association  which  provides  a  common 
meeting  place  and  facilities  for  collection  messengers  to  exchange 
their  reciprocal  claims  on  each  other  and  settle  the  net  balances 
only.  Suppose,  for  example,  that  in  a  city  with  five  clearing 
banks,  the  claims  on  a  certain  day  are  as  follows: 


Claims  By 

Bank  A 

Bank  B 

Bank  C 

Bank  D 

Bank  E 

Total 

Against 

Bank  A 

$1,285,434 

$1,492,398 
482,337 

327,972 
187,764 

$    923,619 
537.948 
292,119 

1,390,188 

$          99,645 

113. 151 

454.638 

54.468 

Bank  B 

f        663,957 
559.527 
724.788 
153.663 

BankC, 

Bank  D 

Bank  E 

651,735 
912,954 
196,761 

1,958,019 
2,020,182 

Total: 

Due  to 

Due  from  . . . 

$     2,101,935 
3,801,096 

$3,046,884 
L797.393 

$2,490,471 
1,958,019 

$3,143,874 
2,020,182 

$        721,902 
1.928,376 

$11,505,066 
11,505,066 

$ — 1,699,161 

$1,249,491 

$    532,452 

$1,123,692 

$ — 1,206,474 

Then  the  equation  of  debit  and  credit  balances  is : 
(1,249,491  +  532,452  +  1,123,692)  =  (1,699,161  +  1,206,474)  =  2,905,635 

The  banks  A  and  E  are  net  debtors  to  banks  B,  C,  and  D,  and  the 
payment  of  $2,905,635  balances  settles  their  combined  clearings 
of  $11,505,066. 

The  economies  of  this  clearing  plan  are  evident.  The  items 
can  be  more  expeditiously  handled  if  put  into  one  messenger's 
box  and  carried  a  short  distance  to  the  clearing  house  than  if  put 
into  many  boxes  and  carried  to  the  respective  drawee  banks. 
Only  the  net  balances  of  the  day's  exchanges  need  be  paid  in 
money  and  carried  in  the  street,  thus  reducing  risk  and  expense, 
and  this  expense  may  be  further  reduced  by  depositing  funds  with 
the  clearing  house  for  clearing  house  certificates  which  may  be 
used  to  settle  balances.    Each  bank  needs  to  carry  a  much  smaller 


BANK  OPERATIONS  AND  FUNCTIONS  103 

amount  of  till  money,  for  the  sums  due  to  and  due  from  the  bank 
are  offset  synchronously  and  the  bank  does  not  have  to  provide 
in  advance  cash  enough  to  pay  the  whole  of  the  sums  due  to  other 
banks.  Finally  a  great  economy  of  time  results,  inasmuch  as 
system  and  uniform  rules  are  devised  for  the  prompt  exchange  of 
items  and  settlemen  t  of  balances.  The  effect  of  the  whole  process 
is  to  offset  indebtedness  and  conserve  the  use  of  money. 

Out-of-Town  Collections 

To  collect  out-of-town  items,  one  system  is  to  effect  arrange- 
ments whereby  the  correspondent  acts  as  agent,  collecting  items 
on  banks  in  its  city  through  the  clearing  house  and  on  banks  in  its 
vicinity  through  subcollecting  agents.  Since  checks  are  payable 
at  the  drawee  bank's  window,  the  drawee  bank  remits  for  the 
proceeds  after  deducting  exchange  charges  presumably  to  cover 
the  expense  of  maintaining  a  balance  with  the  sending  bank 
against  which  drafts  may  be  drawn  to  make  remittances.  The 
law  holds  a  bank  to  the  exercise  of  due  care  in  choosing  collection 
agents  and  to  reasonable  promptness  in  sending  and  remitting  for 
items.  Sending  an  item  directly  to  the  drawee  bank,  however, 
unless  the  principal  bank  expressly  permits  it,  is  held  to  be  negli- 
gence, and  therefore  the  collecting  bank  sends  the  item  to  sub- 
agents  in  the  same  city  as  the  drawee  bank.  The  terms  of 
agreement  between  the  depositor  and  the  collecting  bank  as  to 
collection  charges,  the  time  when  items  are  credited  to  the 
account,  and  the  reciprocity  of  collection  services,  are  various. 
This  system  results  in  indirect  routing  of  items  to  save  col- 
lection charges,  and  therefore  in  too  large  an  amount  of  funds 
being  afloat  in  the  mails. 

To  cut  down  the  expense  of  this  system  of  out-of-town  collec- 
tions, co-operative  "country"  clearing  houses  have  been  estab- 
lished in  some  of  the  chief  cities  as  adjuncts  to  the  city  clearing 
house.  A  member  sends  to  the  country  clearing  house  such  of  its 
out-of-town  items  as  it  desires  and  is  permitted  to  send.    All 


104  MONEY,  CREDIT,  AND  BANKING 

items  on  one  drawee  bank,  or  on  the  banks  of  one  city,  are  put 
into  one  envelope  and  mailed  to  that  bank  or  the  agent  of  the 
clearing  house  in  that  city.  The  bank  or  agent  makes  out  one 
lump  remittance  to  the  clearing  house,  which  settles  with  its 
members.  This  system  of  co-operative  collections  may  go  further 
and  require  all  drawee  banks  to  remit  at  par  for  all  items  sent  to 
them,  and  then  assess  the  expense  of  the  country  clearing  house 
upon  the  depositing  banks  at  so  much  per  item  or  per  dollar 
collected. 


CHAPTER  VII 

PROTECTION  OF  BANK  NOTE  HOLDERS 

Nature  of  Bank  Notes 

In  case  the  seller  of  discount  items  (the  borrower)  or  his  busi- 
ness clientele  does  not  understand  the  deposit-check-paying  sys- 
tem, he  will  probably  ask  that  the  proceeds  be  paid  to  him  in 
cash.  The  bank  then  has  the  alternative  of  paying  him  in  lawful 
money  or  of  paying  him  in  its  own  notes  if  they  have  attained  to 
general  acceptability.  Such  notes  are  simple  promissory  notes 
of  the  bank,  issued  in  round,  small  denominations,  and  promising 
to  pay  the  bearer  on  demand.  The  seller  of  the  discounts  may 
consciously  accept  these  bank  notes  without  hesitancy  because 
he  knows  they  pass  freely  as  money,  or  he  may  accept  them  un- 
consciously through  custom  or  through  ignorance  of  their  exact 
nature. 

Bank  Notes  and  Deposits — Similarity 

Bank  notes  and  bank  deposits  are  essentially  alike.  Both  are 
liabilities  of  the  bank,  deposits  being  payable  to  the  depositor 
or  his  order  as  evidenced  by  the  check,  notes  being  payable  to 
the  holder,  and  both  being  payable  on  demand.  Moreover,  re- 
serves are  held  against  both,  and  both  notes  and  deposits  increase 
the  purchasing  power  of  their  holder  wherever  the  bank's  credit 
is  accepted. 

To  judge  from  the  prevalence  of  erroneous  and  misleading 
statements  by  newspapers  and  the  general  public,  it  would  seem 
that  the  writers  on  banking  theory  have  not  given  sufficient 
emphasis  to  the  essential  likeness  of  bank  notes  and  deposits. 
The  bank  itself  is  largely  indifferent  as  to  which  of  these  two 
forms  of  credit  the  customer  requests,  and  the  customer  acts  as 

105 


106  MONEY,  CREDIT,  AND  BANKING 

occasion  demands,  turning  in  bank  notes  for  credit  to  his  deposit 
account,  or  having  his  check  "cashed"  in  bank  notes,  both  bank 
and  customer  distinguishing  these  two  credit  forms  only  with 
respect  to  convenience.  Neither  form  increases  directly  the 
wealth  of  the  bank,  the  customer,  or  the  country;  they  are  both 
credits  and  give  the  holder  claim  to  existing  wealth,  but  are  not 
themselves  wealth.  The  issue  of  a  billion  dollars  of  bank  notes 
or  the  creation  of  a  billion  dollars  of  deposits  by  the  process  of 
loans  and  discounts  does  not  of  itself  increase  the  wealth  of  the 
country  one  whit.  To  regard  the  deposits  of  the  banks  of  a  coun- 
try as  an  index  of  the  growth  of  the  country's  real  wealth  is  a 
serious  error.  It  is  still  more  serious  to  measure  the  strength  or 
greatness  of  a  bank  or  banking  system  by  its  deposits,  such  a 
measure  indicating  an  error,  not  only  in  not  adding  bank  notes  to 
deposits  but  also  in  regarding  a  liability  of  a  bank  as  an  element 
of  strength.  It  is  assets  alone  which  constitute  the  strength  of 
any  institution. 

The  failure  to  recognize  the  similarity  of  bank  notes  and  de- 
posits appears  most  often,  however,  in  statements  about  inflation. 
It  is  not  often  realized  that  inflation  of  price  levels  is  caused  by 
deposits  no  less  than  by  bank  notes — and  indeed  that  the  in- 
fluence of  deposits  is  the  sooner  felt.  The  offer  of  either  bank 
notes  or  checks  will  effect  a  purchase.  The  mere  existence  of  a 
large  amount  of  either  bank  notes  or  deposits  does  not  affect 
prices;  it  is  only  as  notes  or  deposits  are  offered  for  goods  that  the 
demand  side  of  the  market  expands  and  raises  prices.  In  the 
actual  process  of  economic  life  it  happens  that  purchases,  and 
therefore  inflation,  through  the  medium  of  deposits  often  precede 
inflation  through  the  medium  of  bank  notes.  Generally  in  times 
of  increasing  trade  activity  wholesale  prices  rise  before  retail 
prices,  and  the  wholesale  prices  are  affected  almost  wholly  by 
deposits.  The  dispersion  of  these  deposits  by  manufacturers, 
jobbers,  and  retailers  for  wages  and  materials  requires  circulating 
notes,  which  then  in  the  hands  of  small  holders  occasion  retail 


PROTECTION  OF  BANK  NOTE  HOLDERS       107 

demand  and  consequent  rise  of  retail  prices.  The  point  is  illus- 
trated by  the  recent  process  of  percolation  of  the  huge  war  credits 
through  the  munitions  manufacturers  to  the  wage-earners,  with 
the  consequent  increase  in  the  quantities  of  federal  reserve  notes 
and  the  rise  in  the  cost  of  living. 

Bank  Notes  and  Deposits — Differences 

Although  bank  notes  and  deposits  are  thus  much  alike  in 
nature  and  effects,  they  have,  nevertheless,  fundamental  differ- 
ences. 

Deposits  are  circulated  by  checks  or  drafts — that  is,  orders 
to  pay,  which  are  not  necessarily  obligations  of  the  bank  until 
accepted,  certified,  or  honored  by  the  bank,  and  anyone  who 
is  offered  a  check  may  doubt  the  drawer's  right  to  draw  and 
the  bank's  ability  or  willingness  to  pay.  Moreover,  checks  are 
drawn  in  odd  sums,  large  and  small,  and  are  difficult  to  use  in 
exchange.  The  result  is  that  checks  have  a  limited  acceptability 
— particularly  in  the  country  or  in  backward  communities;  where- 
as bank  notes,  being  direct  obligations  of  well-known  institutions, 
in  sums  of  convenient  size,  and  not  necessitating  indorsement, 
have  a  general  acceptability  and  pass  current  as  money. 

On  the  other  hand,  checks  combine  safety  and  convenience 
in  ways  that  bank  notes  do  not.  The  requirement  of  indorse- 
ment renders  theft  of  a  check  useless  to  the  thief  unless  he 
resorts  to  the  further  crime  of  forgery.  The  security  of  the 
check  is  increased  with  every  indorsement,  which  makes  it 
both  individual  credit  and  bank  credit,  whereas  the  bank  note 
is  wholly  bank  credit.  Another  advantage  of  the  check  is  that 
the  voucher  is  a  receipt  of  payment,  and  still  another  advantage 
is  that  any  amount,  large  or  small,  in  odd  or  even  sum,  can  be 
paid  by  check  with  equal  facility. 

Another  difference  between  the  two  lies  in  the  circumstance 
that  the  depositor  becomes  a  creditor  of  the  bank  voluntarily 
and,  being  usually  a  person  of  business  capacity,  selects  his 


108  MONEY,  CREDIT,  AND  BANKING 

bank  with  more  or  less  acumen,  whereas  a  noteholder  becomes 
a  creditor  of  a  bank  unconsciously,  for  the  most  part,  since 
the  note  passes  current  by  custom.  Then,  too,  deposits  are 
peculiar  to  the  business  and  higher  classes,  while  bank  notes  are 
used  relatively  more  by  a  lower  class  and  get  into  the  hands  of 
persons  who  know  little  if  anything  of  bank  note  issue  or  of  bank- 
ing in  general. 

Finally  bank  checks  and  drafts,  having  but  limited  ac- 
ceptability, are  soon  presented  for  acceptance  or  redemption; 
the  bank  accordingly  constantly  faces  the  necessity  of  provid- 
ing a  reserve  for  this  purpose.  Furthermore,  when  once  received 
by  a  bank,  unlike  bank  notes,  they  cannot  be  paid  out  again 
to  customers  nor  can  they  be  used  for  reserves.  For  its  own 
protection,  therefore,  and  to  make  maximum  use  of  funds,  the 
checks  are  immediately  collected  by  the  bank.  Bank  notes, 
however,  enjoy  a  greater  credit  and  acceptability.  They  circulate 
over  a  broad  field,  they  are  paid  out  again  by  receiving  banks 
unless  prohibited  by  law,  and  they  may  even  be  legally  used  as 
bank  reserve  for  other  than  the  issuing  bank;  consequently  they 
remain  out  in  circulation  for  long  periods.  Their  higher  credit 
removes  the  motive  of  presenting  for  redemption.  Meanwhile 
the  bank  has  felt  less  necessity  for  keeping  a  big  reserve  or  any 
reserve  at  all,  trusting  to  be  able  to  meet  the  few  redemptions  by 
use  of  the  casual  till  money.  Under  such  conditions  there  is  great 
danger  of  failure  of  the  issuing  bank — a  danger  which  grows  apace 
with  the  period  over  which  the  notes  stay  out. 

Reasons  for  Special  Protection  of  Noteholder 

The  proper  protection  of  noteholder  and  depositor  is  an  im- 
portant matter.  Obviously  since  the  noteholder  is  the  more  likely 
to  suffer,  owing  to  his  ignorance  of  the  nature  and  course  of  the 
bank  note,  if  special  protection  is  to  be  given  to  either  class  the 
noteholder  has  the  higher  claim.  Governments  early  felt  it  in- 
cumbent upon  themselves  to  provide  special  protection  to  note- 


PROTECTION  OF  BANK  NOTE  HOLDERS       109 

holders,  but  except  in  the  United  States  they  have  not  felt  a 
corresponding  duty  towards  depositors.  This  difference  is  due  to 
several  reasons.  For  one  thing  the  essential  likeness  of  notes  and 
deposits  has  not  been  generally  perceived.  Then,  too,  the  bank 
note  enters  into  the  circulating  money  of  the  country,  and  the 
state  has  generally  assumed  the  creation  and  regulation  of  its 
money.  Moreover,  the  abuses  of  note  issue  are  more  readily 
discernible  and  the  methods  of  protection  more  easily  devised. 
And  finally  the  depositor  may  reasonably  be  assumed  to  know 
the  state  of  solvency  of  the  bank  of  which  he  is  a  customer.  On 
the  other  hand,  it  would  be  too  much  to  expect  a  person  to  have 
all  this  knowledge  concerning  the  numerous  banks  whose  notes 
pass  through  his  hands  in  the  course  of  his  daily  business.  For 
these  various  reasons  legislatures  have  quite  generally  provided 
more  protection  to  notes  than  to  deposits.  The  United  States, 
with  respect  to  the  national  banks,  and  the  several  states,  with 
respect  to  the  state  banks,  have  been  unique  among  the  govern- 
ments of  the  world  in  devising  protection  to  depositors. 

Currency  Principle  versus  Banking  Principle 

The  matter  of  protection  of  bank  credit  has  been  the  bone  of 
contention  between  two  schools  of  banking  thought — those  who 
believe  in  the  "currency"  principle  and  those  who  adhere  to  the 
"banking"  principle.  The  former  believe  that  bank  notes  by 
entering  the  currency  displace  so  much  gold,  which  is  driven 
abroad,  that  such  an  issue  of  notes  might  completely  expel  the 
gold  and  force  the  country  to  an  inconvertible  depreciated  basis, 
and  that  therefore  the  state,  to  protect  itself  and  its  citizens, 
must  so  regulate  bank  note  issues  as  to  prevent  such  results.  The 
adherents  of  this  theory  would  make  the  bank  notes  practically 
gold  certificates  with  100  per  cent  gold  reserve,  or  if  that  were 
impossible,  would  minimize  the  uncovered  issue. 

It  is  evident  that  this  theory  emphasizes  the  safety  of  the 
currency  but  makes  its  volume  constant  and  inelastic,  neither  of 


IIO  MONEY,  CREDIT,  AND  BANKING 

which  is  desirable.  The  volume  of  bank  notes  should  expand  and 
contract  freely  with  the  needs  of  business ;  if  it  does  not  the  price 
level  must  vary  inversely  as  business  activity,  or  else  the  elasticity 
must  be  provided  by  deposit  currency. 

The  adherents  of  the  banking  principle,  on  the  other  hand, 
hold  that  the  right  of  note  issue  should  be  full  and  unlimited  at 
the  discretion  of  the  banker  who  for  business  reasons,  they  assert, 
will  find  proper  protection  and  reserves  for  noteholders  and  de- 
positors, and  who,  so  long  as  he  keeps  notes  convertible,  can  bring 
neither  the  bank  itself  nor  the  business  community  into  any 
danger.  Should  the  notes  become  inconvertible,  this  theory 
holds  that  a  redundant  depreciated  circulation  would  result,  but 
if  the  notes  are  kept  convertible  the  bank  can  only  put  a  definite 
quantity  into  circulation,  any  excess  being  returned  to  it  for 
redemption  and  for  the  liquidation  of  old  loans. 

This  principle  is  sound  except  that  there  is  no  safeguard 
against  imprudent  and  reckless  banking.  With  conservative 
bankers  the  maintenance  of  convertibility  would  be  unquestioned, 
but  if  bankers  should  become  reckless  and  give  loans  on  easy 
terms  the  note  issue  would  readily  expand  until  the  possibility 
of  converting  upon  demand  would  cease,  provided  demand  were 
at  all  general.  To  curb  the  reckless  banker  and  protect  creditors 
against  his  extravagances  is  the  aim  of  modern  bank  regulation. 

Safeguards  Against  Bank  Insolvency 

The  protection  of  bank  credit  resolves  itself  into  two  general 
lines:  (i)  the  establishment  of  safeguards  against  the  bank's 
insolvency,  and  (2)  special  protection  of  its  creditors  against  the 
suspension  of  specie  payments. 

Insolvency  is  a  condition  existing  when  liabilities,  other  than 
to  stockholders,  exceed  assets;  under  such  a  condition  the  bank 
would  be  unable,  even  after  all  assets  had  been  liquidated,  to  pay 
noteholders  and  depositors  par  on  their  claims.  Insolvency  is 
guarded  against  by  the  owners  of  the  bank  subscribing  capital 


PROTECTION  OP  BANK  NOTE  HOLDERS       III 

and  by  accumulating  a  large  surplus  to  act  as  buffer.  The  capital 
subscribed  should  bear  a  reasonable  ratio  to  the  volume  of  credits 
extended;  the  maximum  amount  of  this  ratio  may  be  decreed  by 
law.  When,  however,  banks  are  organized  and  capitalized,  it  is 
impossible  to  fix  such  capital  requirements  in  advance,  for  no  one 
knows  what  volume  of  business  will  be  the  fortune  of  the  incipient 
bank.  The  state  assumes,  however,  that  the  size  of  the  bank  and 
the  size  of  the  city  in  which  it  is  domiciled  bear  some  ratio,  and 
accordingly  the  minimum  capitalization  of  banks  is  roughly  pro- 
portioned to  the  city's  population. 

Laws  further  require  the  accumulation  of  some  minimum 
surplus,  usually  a  percentage,  20,  30,  or  40  per  cent  of  the  capital, 
during  its  earlier  years.  Any  bank  aspiring  to  greatness  inevi- 
tably accumulates  such  surplus  and  usually  maintains  it  far  in 
excess  of  the  required  minimum;  such  surplus  not  only  is  evidence 
of  strength,  age,  and  conservative  policy,  but  provides  working 
and  earning  funds.  Our  National  Bank  Law  and  some  state  bank 
laws  impose  upon  the  bank  stockholders  a  double  liability — that 
is,  the  stockholders  in  case  of  the  bank's  failure  can  be  held  for  an 
additional  amount  equal  to  the  par  value  of  their  shares,  and  this 
liability  is  a  contingent  asset  of  the  bank.  The  accumulation  of  a 
large  surplus,  however,  renders  the  use  of  this  asset  improbable, 
and  the  growth  of  the  bank's  credits  outstanding  renders  the  pro- 
tection afforded  by  this  double  liability  of  the  stockholders  rela- 
tively less  important.  In  the  light  of  their  dividend  percentages 
most  banks  are  undercapitalized,  but  their  creditors  do  not  suffer 
therefrom  since  the  accumulation  of  surpluses  many  times  the 
size  of  their  capital  serves  the  same  ends  as  a  buffer  against 
insolvency. 

Other  lines  of  protection  against  insolvency  provided  by  law 
are :  by  the  regulation  of  loans  and  business  activities,  by  fixing 
the  maximum  loan  to  any  one  person,  by  forbidding  loans  to  bank 
officers  or  loans  of  certain  kinds,  by  regulating  investments  and 
forbidding  certain  dangerous  forms,  by  restricting  the  incurrence 


112  MONEY,  CREDIT,  AND  BANKING 

of  contingent  liabilities  by  acceptances,  indorsements,  or  guaran- 
ties, and  by  restricting  the  field  of  operations  to  strictly  credit 
transactions.  For  example,  merchandising,  real  estate,  insur- 
ance operations,  and  the  like,  are  usually  prohibited  to  banks. 

Objects  of  Protecting  Bank  Notes 

When  bank  notes  are  given  special  protection,  three  objects 
are  kept  in  view : 

i.  To  keep  the  bank  notes  of  a  going  or  suspended  bank  at 
par. 

2.  To  provide  that  the  noteholder  shall  be  secured  against 

loss,  at  least  ultimately. 

3.  To  provide  for  elasticity  of  issue. 

1.  Maintaining  Parity 

The  first  of  these  objects  may  be  attained  in  several  ways. 

In  Canada,  for  example,  the  note  of  a  suspended  bank  be- 
gins to  bear  interest  at  5  per  cent  from  the  date  of  suspension 
until  it  is  redeemed  by  the  central  authorities  from  a  special 
fund  kept  for  the  purpose;  the  result  is  that  notes  of  suspended 
banks  may  be  preferred  to  notes  of  solvent  banks  and  be  held 
back  as  investments,  while  those  of  the  solvent  banks  are  used 
in  payments. 

Voluntary  or  compulsory  subscription  to  a  common  fund,  in 
proportion  to  each  bank's  issues,  may  be  arranged  and  placed 
with  the  government  or  a  trustee  who  pays  from  the  fund  the 
notes  of  suspended  banks.    This  is  called  the  "safety  fund  system." 

Again  the  state  may  declare  the  notes  legal  tender  in  all  or 
special  cases.  Such  declaration,  like  any  legal-tender  law,  by 
clothing  the  notes  with  debt-paying  power,  tends  to  maintain 
their  circulation  at  par. 

The  best  and  most  general  method  of  keeping  bank  notes 
at  par  is  to  provide  means  of  immediate  and  constant  con- 
vertibility.   If  the  holder  can  at  any  time,  at  his  will  and  with 


PROTECTION  OP  BANK  NOTE  HOLDERS       113 

little  trouble,  convert  his  notes  into  standard  money,  they  will 
not  go  below  par.  Various  devices  for  achieving  immediate  con- 
vertibility have  arisen.  The  issuing  bank  must  ever  accord- 
ing to  its  promise  stand  ready  to  convert  over  its  counter, 
and  if  this  is  done  anyone  within  reasonable  distance  of  the 
bank  might  regard  its  notes  as  good  as  gold.  To  provide  for 
redemptions  at  distant  places  and  thus  give  the  notes  parity  over 
a  wide  area,  a  system  of  local  and  central  redemption  agencies 
may  be  established,  particularly  at  the  chief  money  centers. 
Another  method  of  redemption  for  notes  of  both  active  and  liqui- 
dated banks  is  immediate  redemption  by  a  guarantor.  In  the 
United  States,  national  bank  notes  are  redeemed  by  the  federal 
Treasury  upon  demand,  from  a  fund  contributed  by  the  banks  and 
recouped  by  sale  of  pledged  securities  and  other  assets,  the  gov- 
ernment, at  least  by  implication,  thus  guaranteeing  redemption. 
The  best  means  of  assuring  ability  to  redeem  on  demand  is  to 
require  that  the  issuing  bank  keep  in  its  vaults,  or  with  some  near- 
by institution,  either  a  fixed  amount  of  gold  or  an  amount  bearing 
a  fixed  minimum  ratio  to  the  notes  issued.  The  federal  reserve 
banks,  for  instance,  are  required  to  hold  gold  equal  to  40  per  cent 
of  the  federal  reserve  notes  issued. 

2.  Providing  Payment  at  Par 

The  second  object  in  protecting  bank  note  holders,  namely,  to 
provide  ultimate  payment  at  par  if  immediate  conversion  proves 
impossible,  is  attained  in  several  ways  in  the  different  existing 
banking  systems,  according  to  the  local  or  political  conditions  of 
each  country. 

The  simplest  of  these  various  plans  is  to  give  the  note- 
holder no  more  protection  than  the  depositor  and  to  rely 
upon  the  business  self-interest  of  the  banker.  The  theory  upon 
which  this  method  is  based  is  as  follows:  A  bank  note  is  a 
simple  promise  on  the  part  of  the  bank  to  pay  and  circulates  on 
the  credit  of  the  issuer.     This  credit  is  improved  if  the  bank  has 

VOL.  1—8 


114  MONEY,  CREDIT,  AND  BANKING 

adequate  sound  and  liquid  assets,  for  the  bank  notes  together 
with  the  deposits  are  ultimately  paid  from  the  general  assets. 
Fear  of  failure  and  of  bankruptcy  makes  the  banker  conservative 
in  his  investments,  hence  the  self-interest  of  the  banker,  as  well 
as  the  requirements  of  law  and  government  regulation,  is  as- 
sumed to  provide  adequate  protection  to  the  noteholder.  This 
method  of  attaining  ultimate  payment  at  par,  while  theoretically 
sound,  has  proved  delusive  and  dangerous,  particularly  in  the 
early  history  of  our  state  banking.  It  works  best  in  old  districts 
in  which  banks,  chastened  and  taught  by  failures,  have  assumed 
a  full  responsibility  for  the  continuous  and  conservative  financial 
welfare  of  the  district.  It  is  also  less  likely  to  succeed  in  a 
decentralized  system  of  note  issue,  where  competing  banks  act 
independently  and  for  their  own  advantage  and  exercise  little 
or  no  restraint  on  a  bank  which  is  known  to  be  overextended. 

Where  it  is  desired  to  give  more  protection  to  notes  than  to 
deposits,  the  notes  may  be  given  a  prior  hen  on  the  general 
assets,  that  is,  after  the  notes  have  been  liquidated  at  par  the 
depositors  are  entitled  to  the  remaining  assets.  It  is  evident 
that  by  the  prior  lien  noteholders  are  protected  at  the  expense  of 
depositors.  The  bank  note  systems  of  France  and  Canada  illus- 
trate these  two  schemes  respectively. 

In  general,  however,  the  issuance  of  bank  notes  is  regulated  in 
the  interest  of  the  holders,  and  these  regulations  are  supposed  to 
provide  indirectly  for  security.  The  plans  for  such  regulation 
are  numerous. 

One  method  is  to  restrict  the  issue  to  certain  banks.  The 
central  banks  of  England,  Germany,  and  France  enjoy  practical 
monopolies  of  issue  in  their  respective  countries;  these  banks 
are  exceptionally  strong  and  are  moved  by  a  public  interest 
which  does  not  generally  characterize  local  banks.  In  England 
this  restriction  allocates  the  issues  still  more  by  placing  that 
activity  entirely  in  the  hands  of  the  Issue  Department,  a  plan 
which  results  in  a  clear-cut  separation  of  loans  and  issue,  mak- 


PROTECTION  OF  BANK  NOTE  HOLDERS       115 

ing  baneful  collusion  of  bank  officers,  as  well  as  trespasses  on  the 
law,  less  easy  and  secret. 

A  second  method  is  to  restrict  the  amount  of  the  aggregate 
issue.  The  limit  may  be  absolutely  fixed  at  so  many  milliards, 
as  in  France  or  Germany,  or  be  limited  according  to  the  gov- 
ernment debt  or  the  issuing  bank's  capital,  as  in  the  United 
States.  The  limit  fixed  may  or  may  not  be  elastic — the  5  per 
cent  tax  on  the  excess  as  used  in  Germany,  or  the  Aldrich- 
Vreeland  Currency  Associations  formerly  used  in  the  United 
States,  illustrates  the  elastic  limit.  Indirect  limitations  may  be 
imposed  in  various  ways,  such  as  by: 

1.  Allowing  only  large  denominations  which  will  not  circu- 

late freely — for  instance,  the  Bank  of  England  note  and 
the  national  bank  note  are  relatively  large  denomina- 
tions. 

2.  Requiring  immediate  clearance  and  redemption,  as  in 

Canada. 

3.  Limiting  the  area  of  circulation. 

4.  Guarding  the  nature  of  loans  and  assets  and  supervising 

the  banks'  practices  through  legal  restraints,  regula- 
tions, examinations,  and  reports.  These  methods  of 
indirect  limitation  are  combined  in  varying  degrees  and 
ways. 

A  third  group  of  methods  of  protecting  noteholders  with  ulti- 
mate security  is  to  pledge  special  assets.  The  segregation  of  these 
assets,  usually  those  of  better  quality  than  the  rest,  for  the  special 
security  of  bank  notes  is  made  to  the  detriment  of  the  security  for 
deposits.  This  partiality  is  shown  to  notes  because  legislatures, 
for  previously  mentioned  reasons,  regard  the  noteholder  as  a 
more  immediate  ward  of  the  state. 

The  particular  assets  set  aside  for  the  protection  of  the  note- 
holders are  usually  high-quality  assets,  such  as  mortgages  or 
government  bonds,  and  are  pledged  with  the  government,  which 


116  MONEY,  CREDIT,  AND  BANKING 

is  authorized  to  sell  the  bonds  and  redeem  the  outstanding  notes. 
Commercial  papers,  such  as  notes  and  acceptances  of  tradesmen 
and  manufacturers,  are  very  serviceable  assets  for  use  as  a  pledge 
against  notes,  because  they  open  a  way  to  procure  elasticity. 

Another  system  of  affording  security  is  to  have  a  government 
or  other  large  institution  or  group  of  institutions  stand  guarantor 
of  the  notes  issued.  The  security  of  the  notes  is  then  that  of 
both  the  commercial  world  and  the  government  or  guaranteeing 
institution.  The  best  example  of  this  system  is  our  national  bank 
system,  for  the  notes  of  which  our  federal  Treasury  stands  prac- 
tical guarantor. 

3.  Elasticity  of  Note  Issues 

The  great  danger  in  any  system  of  protection  of  note  issues  is 
that  the  restrictions  may  be  so  rigid  as  to  destroy  or  unduly  cir- 
cumscribe elasticity  of  issue.  A  note  issue  should  be  capable  of 
expanding  suddenly  and  greatly  in  case  of  emergency,  and  of 
contracting  as  readily  when  the  emergency  subsides.  It  should 
also  be  able  to  increase  and  decrease  with  the  seasonal  demands 
for  money.  The  term  "elasticity"  is  strictly  applicable  to  the 
latter  case  only.    Elasticity  of  the  currency  is  desirable  so  that: 

1.  Accommodation,  particularly  to  deserving  and  efficient 

borrowers,  can  be  extended  freely  and  the  continuity  of 
business  maintained. 

2.  The  market  rate  of  interest  may  be  stabilized  and  fluctua- 

tions of  credit  reduced. 

3.  The  quantity  of  money  rather  than  the  price  level  may 

fluctuate  seasonally. 

It  is  highly  desirable  that  an  expansion  or  contraction  of  the 
volume  of  bank  notes  should  be  unmistakably  in  response,  re- 
spectively, to  an  increased  or  lessened  demand  of  the  legitimate 
business  world — a  demand  not  based,  except  to  a  relatively  small 
degree,  on  speculative  operations  but  on  actual  industrial  and, 


PROTECTION  OF  BANK  NOTE  HOLDERS       117 

commercial  operations.  This  correlation  may  be  most  surely 
achieved  by  issuing  bank  notes  only  to  borrowers  who  use  the 
funds  only  for  such  legitimate  purposes.  In  practice  the  persons 
who  decide  whether  the  purpose  alleged  is  legitimate,  and  who 
watch  to  see  that  the  loans  are  used  for  the  alleged  purpose,  are 
the  loaning  bankers. 

Methods  of  Attaining  Elasticity 

One  method  for  bringing  about  the  desired  correlation  be- 
tween the  expansion  or  contraction  of  the  volume  of  bank  notes 
and  the  increased  or  lessened  demand  of  the  business  world  is 
to  allocate  the  issue  function  to  a  central  body  and  require  the 
pledge  of  strictly  denned  commercial  paper,  bearing  evidence  of 
its  commercial  origin  and  use,  as  the  basis  of  notes  issued.  If  the 
quantity  of  such  eligible  paper  increases  in  response  to  seasonal 
development  of  trade,  more  may  be  pledged  as  security  for  bank 
note  issues.  When  business  again  slumps,  the  payment  of  the 
commercial  paper  will  recall  the  bank  notes. 

It  is  evident  that  such  seasonal  responsiveness  is  defeated  if 
the  volume  of  bank  notes  depends  upon  long-term  investments 
instead  of  self-liquidating  paper,  for  there  is  no  assurance  that  the 
funds  are  being  used  for  the  alleged  original  purpose,  or,  having 
been  so  used,  that  they  are  not  being  used  in  subsequent  illegiti- 
mate operations.  Moreover  the  loaning  bank,  feeling  amply 
secured  and  perhaps  therefore  indifferent  as  to  the  uses  to  which 
the  loan  is  put,  may  freely  renew  the  loan  until  it  becomes  prac- 
tically a  continuous  loan;  the  request  for  renewal  would  never 
have  been  made,  however,  if  the  loan  had  been  self-liquidating. 
The  ideal  collateral  for  bank  note  issues  is,  therefore,  strictly 
self-liquidating  commercial  and  industrial  paper  of  short  usance. 

It  is  not  impossible,  of  course,  to  effect  elasticity,  even  though 
the  bank  notes  are  secured  by  pledge  of  stocks  and  bonds  or  other 
permanent  investments,  provided  bankers  assure  themselves  that 
the  funds  are  used  in  short-term  commercial  and  industrial  ways 


118  MONEY,  CREDIT,  AND  BANKING 

and  that  they  are  withdrawn  from  circulation  when  those  uses 
have  ceased.  In  fact,  it  may  be  very  desirable  to  issue  bank  notes 
freely  upon  the  basis  of  promissory  notes  secured  by  pledge  of 
bonds  and  other  investment  securities.  In  the  United  States 
during  the  late  war,  the  great  disturbances  of  the  money  market 
occasioned  by  war  financing  were  very  much  alleviated  by  the 
legal  possibility  of  rediscounting  such  war  paper  and  procuring 
in  this  way  federal  reserve  notes  or  credit  with  the  federal  reserve 
banks.  In  this  case  the  need  for  currency  was  oftentimes  too 
suddenly  and  too  greatly  increased  to  place  dependence  upon 
pledging  strictly  commercial  paper,  the  volume  being  too  small  or 
too  constant,  and  it  was  expedient,  therefore,  to  provide  for  direct 
loans  by  the  federal  reserve  banks  against  government  securities, 
or  for  rediscounting  war  paper  given  to  member  banks  by  loan 
subscribers. 

If  no  limitations  are  laid  by  law  on  credit  issues,  the  bankers 
will  of  their  own  accord  normally  provide  elastic  note  issues  and 
elastic  deposit  currency.  The  needs  of  the  business  world  will  be 
indicated  by  the  aggregate  of  applications  for  loans  and  by  the 
rates  of  interest  that  borrowers  are  willing  to  pay.  As  loans  and 
discounts  expand,  deposits  and  note  issues  will  expand  in  piopor- 
tion;  and  subsequently,  when  business  men  sell  their  stores  of 
goods  or  realize  upon  their  customers'  accounts,  the  loans  at  the 
bank  will  be  lifted,  the  deposits  canceled,  and  the  notes  retired. 
If  the  state  requires  a  minimum  percentage  reserve  in  gold  against 
notes  or  deposits,  or  both,  it  is  evident  that  a  maximum  for  the 
issue  is  fixed  by  the  gold  in  the  bank's  reserves.  If  the  state  goes 
further  and  allows  issues  only  against  certain  assets  specifically 
pledged,  a  more  rigid  limit  is  put  on  the  issue  and,  as  in  the  case 
of  our  national  bank  note,  all  elasticity  may  be  forfeited.  The 
federal  reserve  system  has  a  plan  for  pledging  commercial  papers 
as  collateral  for  notes  which  achieves  elasticity  of  issue. 

Elasticity  cannot  be  attained  simply  by  providing  a  means  of 
expanding  the  issue;  it  must  also  provide  for  contracting  the  issue 


PROTECTION  OF  BANK  NOTE  HOLDERS       119 

by  redemption  when  the  exigency  has  passed.  If  a  banker  might 
issue  his  own  notes  freely,  self-interest  would  incline  him  to  with- 
draw from  circulation  the  notes  of  other  banks  and  fill  their  place 
with  his  own;  if  he  could  not  use  them  for  reserves  nor  pay  them 
out  over  his  counter,  they  would  be  idle  funds  in  his  hands  and  he 
would  send  them  for  redemption  at  once.  If  a  loan  were  paid  with 
bank  notes  of  the  loaning  bank,  the  notes  in  circulation  would 
contract  by  that  amount;  if  it  were  paid  with  bank  notes  of 
another  bank  and  the  loaning  bank  were  to  send  those  notes 
immediately  to  the  issuing  bank  for  redemption,  the  circulation 
would  be  likewise  reduced;  under  such  conditions,  checks  and 
bank  notes  would  be  cleared  at  once  and  together.  This  is  the 
situation  in  Canada. 

It  is  to  be  noted  that  the  restrictions  which  defeat  elasticity 
of  bank  notes  may  not  defeat  elasticity  of  the  country's  aggregate 
currency;  elasticity  may  be  secured  through  issue  of  government 
paper  money  or  by  deposit  currency.  England,  for  example,  has 
a  very  inelastic  bank  note  system,  but  its  deposits  expand  and 
contract  freely  to  conform  with  business  needs.  If  the  deposit- 
check  system  is  thoroughly  understood  throughout  the  country, 
there  is  relatively  little  need  of  an  elastic  note  issue.  In  actual 
practice,  however,  large  industrial  classes,  such  as  wage-earners, 
and  large  geographical  areas,  such  as  the  agricultural  South  and 
Northwest  of  our  own  country,  find  checks  inconvenient,  and  the 
seasonal  demands  for  means  of  payment  are  best  met  by  an  elastic 
note  issue.  As  deposit  banking  permeates  the  United  States  the 
evils  of  the  inelastic  national  bank  note  are  reduced. 

Existing  Systems  of  Protecting  Bank  Notes 

Differences  of  historical,  political,  and  economic  nature  in  the 
leading  commercial  countries  of  the  world  have  resulted  in  various 
adaptations  of  the  methods  of  protecting  bank  notes,  as  given  in 
the  foregoing  section.  These  adaptations  may  be  briefly  sum- 
marized as  follows. 


120  MONEY,  CREDIT,  AND  BANKING 

Bank  Notes  in  France 

The  Bank  of  France  has  a  monopoly  of  the  note  issue  privilege. 
The  notes  are  a  legal  tender  for  all  debts.  They  are  secured  by 
the  general  assets  of  the  bank,  but  they  are  not  given  a  prior  lien 
on  these  assets.  The  law  does  not  compel  the  bank  to  keep  any 
specific  reserve,  but  the  bank  has  been  conservative  and  has 
accumulated  a  large  specie  reserve  of  gold  and  silver.  Besides  its 
specie  reserve  the  bank's  assets  normally  contain  large  quantities 
of  prime  commercial  paper.  The  issue  of  bank  notes  takes  place 
ordinarily  through  the  rediscounting  of  two-name  paper,  in  large 
part  of  small  denominations,  to  which  the  banking  house  that 
sells  the  paper  adds  a  third  name.  The  war  had  the  effect  of 
loading  the  assets  with  government  securities.  From  time  to 
time  the  government  fixes  a  maximum  figure  for  the  circulation 
of  these  notes,  but  as  the  figure  is  usually  raised  in  advance  of 
needs,  this  is  not  a  real  restraint.  While  the  bank  may  redeem 
in  either  gold  or  silver,  a  stubborn  refusal  to  pay  gold  would 
create  adverse  public  sentiment;  the  bank,  accordingly,  offers  to 
make  gold  payments  at  a  premium  in  currency  when  such  con- 
cession seems  advisable,  and  in  this  way  it  controls  the  exporta- 
tion of  gold  and  protects  its  reserves.  The  deposit  business  in 
France  is  very  small  indeed,  but  elasticity  of  both  notes  and  de- 
posits is  well  attained. 

Bank  Notes  in  England 

The  Bank  of  England,  to  which  the  note  issue  privilege  sur- 
rendered by  other  banks  accrued  under  the  Bank  Act  of  1844,  the 
"Peel  Act,"  has  a  practical  monopoly  of  the  bank  note  issue  in 
England.  The  English  bank  note  system  is  based  on  the  currency 
principle.  To  the  amount  of  £18.45  million  the  issue  is  secured  by 
government  and  other  securities,  this  portion  of  the  issue  being 
called  the  "uncovered"  issue.  All  in  excess  of  that  amount  is 
secured  pound  for  pound  with  gold. 

The  Bank  of  England  is  divided  into  two  distinct  parts — the 


PROTECTION  OF  BANK  NOTE  HOLDERS       121 

Issue  Department  and  the  Banking  Department.  The  Issue 
Department  is  charged  with  the  sole  and  exclusive  function  of 
the  issue  and  redemption  of  bank  notes;  the  Banking  Department 
handles  discounts,  loans,  and  deposits.  The  Banking  Department 
procures  notes  from  the  Issue  Department  in  the  same  way  as 
does  any  holder  of  coin  or  bullion,  that  is,  by  the  exchange  of 
gold  for  notes.  In  making  loans  the  Banking  Department  gen- 
erally credits  the  borrower  with  deposits,  but  it  may  pay  out 
notes  or  gold;  the  same  is  true  of  any  payment  by  the  Banking 
Department.  A  large  part  of  the  outstanding  bank  notes  are 
found  in  the  vaults  of  the  Banking  Department  and  constitute  a 
portion  of  its  reserves;  they  simply  represent  so  much  gold  kept 
in  the  Issue  Department. 

Bank  notes  of  the  Bank  of  England  may  be  used  as  reserve  by 
the  other  banks  whose  reserves  consist  of  "  Cash  and  Due  from  the 
Bank  of  England."  The  "Cash"  includes  many  notes  of  the  Bank 
of  England,  and  the  portion  described  as  "Due  from  the  Bank  of 
England"  consists  largely  of  balances  carried  with  the  Bank 
of  England  by  the  local  bank. 

The  uncovered  issue  of  the  Bank  of  England  is  fixed  in  amount, 
but  the  covered  issue,  which  consists  really  of  certificates  of 
deposit,  can  expand  indefinitely.  With  every  increase  of  the 
covered  issue,  the  per  cent  reserve  against  the  total  issue  is  in- 
creased. As  a  result  the  bank  notes  are  absolutely  safe  but 
wholly  inelastic;  to  increase  the  total  volume  of  the  country's 
currency  by  the  method  of  note  issue  is  impossible,  since  gold  is 
simply  exchanged  for  an  equal  amount  of  bank  notes.  In  financial 
crises  the  system  breaks  down;  five  times  it  has  been  found  nec- 
essary to  disregard  the  legal  limitations  on  the  uncovered  issue. 
On  such  occasions  Parliament  suspends  the  Law  of  1844  and  so 
enables  the  Banking  Department  to  carry  to  the  Issue  Depart- 
ment more  government  securities  in  exchange  for  bank  notes. 
These  suspensions  are  temporary,  and  as  soon  as  the  crisis  is 
passed  the  Banking  Department  recovers  its  securities  by  paying 


122  MONEY,  CREDIT,  AND  BANKING 

bank  notes.  Because  of  the  limitations  on  bank  note  issue  and 
because  of  the  greater  utility  of  deposits,  deposit  banking  largely 
supplants  note  issue  in  England. 

Bank  Notes  in  Germany 

The  monopoly  of  note  issue  in  Germany  is  conferred  by  law 
upon  the  Reichsbank  and  four  other  joint-stock  banks;  in  case 
of  the  surrender  of  the  note-issuing  power  by  any  of  the  four  the 
privilege  accrues  to  the  Reichsbank.  By  the  Law  of  1909  the 
maximum  limit  of  the  uncovered  issue  was  fixed  at  550,000,000 
marks,  with  the  provision  that  for  the  last  week  of  each  fiscal 
quarter,  when  the  volume  of  payments  runs  high,  the  limit  is 
750,000,000.  The  uncovered  issue  is  based  upon  commercial 
paper  in  the  Reichsbank's  portfolio;  during  the  war,  indeed, 
treasury  certificates  of  indebtedness  were  declared  to  be  eligible 
cover.  No  limit  is  set  for  the  total  issue  of  bank  notes,  but  any 
amount  in  excess  of  the  legal  limit  of  the  covered  issue  must  be 
secured  by  an  equal  amount  of  cash,  and  any  excess  not  so  secured 
by  cash  is  subject  to  a  tax  of  5  per  cent  per  annum.  During  the 
war  the  Darlehnkassenscheine  (a  special  form  of  currency  issued 
by  loan  societies  upon  the  security  of  bonds,  stocks,  and  so  forth) 
were  declared  by  law  to  be  "cash"  and  eligible  cover  for  bank 
notes.  Of  course,  the  pyramiding  of  notes  made  possible  by  these 
provisions  promoted  inflation  of  the  German  currency. 

The  5  per  cent  " elastic  limit"  device,  which  is  a  less  awkward 
method  of  permitting  emergency  issue  than  the  English  system 
of  suspending  the  Bank  Act,  has  been  resorted  to  quite  frequently. 
The  frequency  of  its  use  has,  in  fact,  been  the  occasion  of  fixing 
a  higher  amount  for  the  uncovered  issue.  In  practice  the  Reichs- 
bank has  not  been  influenced  greatly  by  the  5  per  cent  tax;  it  has 
often  paid  the  tax,  loaned  the  notes  at  3  or  4  per  cent,  and  borne 
the  loss,  when  financial  exigencies  or  public  responsibilities  seemed 
to  warrant.  Under  present  practices,  therefore,  there  are  no 
great  reasons  for  retaining  the  tax,  since  the  volume  of  notes 


PROTECTION  OF  BANK  NOTE  HOLDERS       1 23 

depends  rather  upon  the  will  of  the  bank  administrators  than 
upon  money  rates.  In  former  times  the  tax  probably  served  a 
useful  function  as  a  danger  signal. 

The  cash  in  the  vaults  of  the  note-issuing  German  banks  con- 
sists of  gold  and  silver  coins,  gold  bullion,  imperial  treasury  notes, 
Darlehnkassenscheine,  and  notes  of  other  banks.  The  law  re- 
quires that  the  cash  held  exclusive  of  the  notes  of  other  banks 
be  equal  in  any  case  to  at  least  one-third  of  the  total  circulation, 
and  that  notes  not  covered  by  cash  be  covered  by  discounted 
commercial  paper  having  not  more  than  three  months  to  run  until 
maturity  and  bearing  three  indorsements  or  not  less  than  two 
names  of  well-known  solvency.  Neither  the  cash  nor  the  com- 
mercial paper  is  specifically  pledged,  however,  against  the  notes, 
for  both  remain  in  the  general  fund  and  portfolio  of  the  issuing 
bank;  nor  are  the  noteholders  given  any  special  lien  on  these 
assets.  The  system  simply  means  that  the  assets  on  which  the 
issue  of  notes  is  based  consist  of  cash  and  very  liquid  commercial 
paper. 

The  issue  of  notes  for  gold  is  purely  a  matter  of  convenience 
to  the  holder;  it  helps  to  provide  a  large  gold  reserve  but  no 
elasticity  is  achieved.  The  issue  of  notes  for  rediscounted  paper, 
however,  within  the  limit  of  the  uncovered  issue,  provides  an 
elastic  note  system,  and  the  device  of  the  5  per  cent  elastic  limit 
allows  for  emergency  issues.  The  Reichsbank  before  the  war 
carried  a  large  reserve  of  gold  and  silver.  The  government  re- 
quired the  issuing  bank  to  keep  its  notes  strictly  convertible, 
redeeming  them  over  its  counter.  The  four  issuing  banks,  other 
than  the  Reichsbank,  were  required  to  maintain  redemption  offices 
at  Berlin  and  Frankfort;  the  Reichsbank  redeems  its  notes  also 
at  its  branches.  The  bank  notes  are  a  lawful  tender  to  any  other 
bank  of  issue  and  must  be  received  at  par,  and  notes  thus  received 
must  be  presented  for  redemption  or  be  used  in  payments  to  the 
issuing  bank  or  in  the  issuing  bank's  home  city.  Since  1909  the 
Reichsbank  notes  have  been  a  full  legal  tender. 


124  MONEY,  CREDIT,  AND  BANKING 

Altogether  the  issue  of  bank  notes  in  Germany  has  been  a  very 
important  side  of  banking,  for  deposit  banking  has  until  recently 
developed  but  little. 

Bank  Notes  of  Canada 

The  Canadian  banking  system  consists  of  19  banking  cor- 
porations, with  4,000  branch  offices,  including  1 24  branches  out- 
side of  Canada.  These  19  banks  are  empowered  to  issue  notes 
at  their  main  offices  and  through  their  branches.  The  banking 
system  is  characterized  by  a  great  freedom  from  legislative  inter- 
ference. The  notes  are  secured  by  the  general  assets  of  the  bank, 
and  the  noteholders  are  given  a  prior  lien.  Each  bank  is  per- 
mitted to  issue  notes  up  to  the  amount  of  its  unimpaired  paid-up 
capital.  There  has  been  little  practical  reason  for  such  limitation, 
for  the  circulation  hardly  ever  exceeds  60  per  cent  of  the  paid-up 
capital;  the  limitation  does,  however,  force  the  banks,  as  their 
volume  of  notes  expands,  to  pay  in  more  of  their  capitalization, 
and  these  contributions  of  the  stockholders  increase  the  security 
of  the  creditors.  At  times  when  the  note  circulation  of  a  bank 
approaches  its  limit,  say,  90  per  cent  of  its  capitalization,  that 
bank  tells  its  branches  to  cease  giving  out  notes.  When  it  reaches 
the  limit,  it  uses  the  notes  of  other  banks,  paying  them  out  over 
its  counter,  and  to  get  such  notes  it  borrows  from  banks  which 
have  not  reached  their  limit. 

A  bank  during  crop-moving  season  (from  March  to  August, 
inclusive)  may  issue  notes  in  excess  of  paid-up  capital  to  an 
amount  equal  to  15  per  cent  of  its  combined  paid-up  capital  and 
surplus.  This  emergency  issue  is  subject  to  a  tax  of  5  per  cent  or 
less  per  annum,  the  rate  being  fixed  by  the  governor  in  council. 
These  emergency  notes  are  of  the  same  quality,  style,  and  de- 
nominations as  the  ordinary  notes. 

By  an  Act  of  19 13  provision  was  made  for  what  are  called 
"reserve"  notes.  Beyond  the  limits  set  forth  above  the  bank 
may  issue  any  amount  of  notes  it  desires,  provided  it  deposits 


PROTECTION  OF  BANK  NOTE  HOLDERS       1 25 

with  the  board  of  trustees  at  Montreal  gold  or  Dominion  notes  to 
the  full  amount  of  notes  issued  in  excess  of  the  limits.  These 
notes  and  the  ordinary  bank  notes  are  identical  in  form,  and  on 
the  issue  thus  covered  by  gold  and  Dominion  notes  there  is  no 
tax.  The  banks  send  their  idle  reserve  gold  to  Montreal  to  cover 
such  new  notes,  and  this  gold  may  be  recalled  when  it  is  no  longer 
needed  for  that  purpose. 

The  smallest  denomination  of  bank  note  is  $5,  and  all  the 
notes  are  multiples  of  $5.  The  Dominion  notes  are  $1  and  $2 
notes  issued  by  the  government  to  an  amount  of  $30,000,000, 
against  which  it  keeps  a  25  per  cent  gold  reserve;  any  amount  in 
excess  of  these  $30,000,000  may  be  issued  upon  deposit  of  gold 
for  the  full  amount.  The  Dominion  notes  are  therefore  some- 
what like  our  greenbacks  and  gold  certificates,  but  it  is  obvious 
that  bank  notes,  because  of  their  larger  denominations,  cannot 
displace  the  Dominion  notes  in  circulation,  nor  vice  versa;  they 
are  not  competitive. 

The  law  of  Canada  does  not  require  any  specific  per  cent 
reserve  against  the  bank  notes,  but  does  require  that  at  least  40 
per  cent  of  the  reserve  consist  of  Dominion  notes.  An  opinion 
has  grown  up  in  Canada  that  a  reserve  of  not  less  than  15  per 
cent  of  demand  liabilities  should  be  held  in  gold  and  Dominion 
notes,  and  if  a  bank  falls  below  this  percentage  it  is  admonished 
by  the  Canadian  Bankers'  Association.  By  law  bank  notes  are 
redeemable  in  specie,  but  banks  in  making  ordinary  payments 
are  required  to  pay  amounts  up  to  $100  in  Dominion  notes  if  the 
payee  requests  it. 

In  order  to  effect  uniformity  and  to  prevent  fraudulent  issue, 
in  1900  the  Canadian  Bankers'  Association  was  by  law  given 
power  to  regulate  the  making  and  issue  of  bank  notes,  to  report 
to  the  government  all  overissues,  to  care  for  the  destruction  of 
worn  and  mutilated  notes,  and  to  take  charge  of  suspended  banks. 
Its  main  office,  in  charge  of  a  Secretary,  is  at  Ottawa.  The  worn 
and  mutilated  notes  are  sent  to  the  Secretary  and  destroyed  in 


126  MONEY,  CREDIT,  AND  BANKING 

the  presence  of  witnesses,  and  new  notes  issued  to  replace  them. 
The  bank  note  printing  companies  report  to  the  Secretary 
monthly  the  amounts  of  notes  issued  to  the  respective  banks,  and 
the  Secretary  compares  these  with  similar  statements  from  the 
banks  as  to  notes  received.  The  system  is  not  so  highly  cen- 
tralized as  our  national  bank  note  issue  is  in  the  hands  of  the 
Comptroller  of  the  Currency. 

It  remains  to  add  that  in  Canada  bank  notes  are  not  legal 
tender,  nor  are  banks  obliged  to  receive  the  notes  of  other  banks. 

A  unique  feature  in  the  Canadian  bank  note  system  is  the 
bank  circulation  redemption  fund,  or  safety  fund.  Started  in 
1890,  the  fund  was  raised  by  contributions  from  the  banks  to  an 
amount  equal  to  5  per  cent  of  the  average  circulation  of  each 
contributing  bank.  The  fund  consists  of  gold  and  Dominion 
notes,  lodged  in  the  hands  of  the  Minister  of  Finance,  and  bears 
interest  at  3  per  cent  per  annum.  The  sole  object  of  the  fund  is 
to  make  payment  of  the  notes  of  banks  that  have  failed;  the 
notes  of  such  a  bank  are  redeemed  from  the  fund  without  regard 
to  the  amount  which  that  bank  may  have  paid  into  the  fund. 
If  the  amount  of  redemptions  plus  interest  on  redeemed  notes 
exceeds  the  sum  it  contributed,  the  other  banks  are  required  to 
make  good  the  excess;  the  Minister  of  Finance  assesses  this 
excess  upon  the  other  banks,  but  the  assessments  in  any  year 
may  not  exceed  1  per  cent  of  their  circulation.  All  such  assess- 
ments are  reimbursed  to  the  banks  when  they  are  recovered  from 
the  assets  of  the  failed  bank,  on  which  assets  the  notes  are  a  prior 
claim.  The  fund  serves  the  purpose  of  a  compulsory  mutual 
insurance  of  bank  note  issues,  in  which  the  banks  have  an  intense 
interest  as  to  the  right  conduct  of  their  sister  banks. 

The  notes  of  failed  banks  bear  interest  at  5  per  cent  per  annum 
from  the  date  of  suspension  to  the  date  announced  for  payment. 
Such  notes  are  regarded,  therefore,  as  5  per  cent  investments  to 
the  date  of  redemption,  and  the  notes  of  these  banks  may  be 
actually  more  valuable  than  the  notes  of  solvent  banks.    The 


PROTECTION  OF  BANK  NOTE  HOLDERS  127 

holders  have,  at  least,  no  difficulty  in  selling  them  at  par  to  other 
banks,  brokers,  or  persons  having  money  for  temporary  invest- 
ment. Instead  of  protractedly  circulating  at  a  depreciated  value, 
the  investment  quality  of  these  notes  keeps  them  at  par  and  with- 
draws them  from  circulation. 

Every  bank  is  required  to  redeem  its  notes  at  its  head  office 
and  in  such  commercial  centers  as  are  designated  by  the  Treasury 
Board.  At  present  the  redemption  cities  for  all  the  banks  in 
common  are  Toronto,  Montreal,  Halifax,  Winnipeg,  Victoria, 
St.  John,  and  Charlotte  town.  The  many  redemption  offices 
make  it  easy  to  redeem  the  notes,  the  distances  are  short,  and 
there  is  no  charge  for  exchange. 

Banks  issue  notes  freely,  both  at  the  home  office  and  the 
branches,  as  loans  and  discounts  are  made;  such  loans  and  dis- 
counts are  paid  in  bank  notes  or  credited  as  deposits;  when  these 
loans  are  repaid  later  the  means  of  payment  are  five  in  number,  viz. : 

1.  Gold  or  Dominion  notes — these  increase  the  bank's  re- 

serve and  decrease  the  total  currency  of  the  country. 

2.  Checks  against  the  loaning  bank — these  leave  the  notes 

outstanding  at  the  same  amount,  but  reduce  its  deposit 
liabilities. 

3.  Checks  against  other  banks — these  are  cleared  and  col- 

lected. 

4.  Bank  notes  of  the  loaning  bank — these  reduce  its  bank 

note  liabilities  and  the  total  bank  note  currency  of  the 
country. 

5.  Bank  notes  of  other  banks — these  are  sent  at  once  to  the 

redemption  offices  or  to  the  issuing  bank  for  redemp- 
tion, or  if  the  head  office  or  a  branch  of  the  issuing 
bank  is  in  the  same  town  as  the  loaning  bank,  the  notes 
are  enclosed  along  with  the  checks  in  the  exchanges  for 
the  clearing  house,  for,  although  branches  are  not  re- 
quired to  redeem  notes  of  the  parent  bank,  they  are 
required  to  accept  them  at  par  in  payment  of  all  dues. 


128  MONEY,  CREDIT,  AND  BANKING 

Every  bank  strives  to  put  out  into  circulation  its  own  notes, 
but  at  the  same  time  to  bring  about  the  redemption  of  the  notes 
of  all  other  banks  when  tendered  in  payments  or  for  deposit. 
The  branches  facilitate  the  bank  note  system  by  providing  facili- 
ties for  maintaining  uppliesof  notes  handy  to  borrowers.  Though 
the  bank  notes  acquire  a  national  circulation,  they  do  not  stay 
out  in  circulation  but  are  speedily  returned  for  redemption.  The 
result  is  an  aim  st  perfect  elasticity  of  note  issue;  the  curve  of  the 
combined  outstanding  issues  is  highly  symmetrical  from  year  to 
year,  the  fluctuations  ranging  between  15  and  20  per  cent,  the 
maximum  issue  coming  in  October,  the  minimum  in  January. 
The  spring  revival  calls  out  some  extra  notes,  but  the  big  issues 
start  in  August  and  decline  in  November. 

Bank  Notes  in  the  United  States 

These  include  national  bank  notes,  federal  reserve  bank  notes, 
and  federal  reserve  notes,  and  will  be  described  in  Volume  II, 
Chapter  XIX. 


CHAPTER  VIII 
PROTECTION  OF  DEPOSITORS 

Special  Protection  in  the  United  States 

For  reasons  presented  in  the  preceding  chapter,  the  state  has 
not  been  as  solicitous  for  the  protection  of  depositors  as  it  has  for 
the  protection  of  noteholders.  Indeed,  much  of  the  protection  to 
noteholders  has  been  given  to  the  direct  detriment  of  the  deposi- 
tors. For  instance,  the  segregation  of  some  of  the  best  assets  of 
the  bank  (government  bonds,  prime  commercial  paper,  gold, 
etc.)  as  specific  security  for  outstanding  bank  notes,  weakens  the 
security  for  the  deposits;  giving  noteholders  a  first  and  paramount 
lien  on  the  assets  of  a  failed  bank  has  the  same  effect. 

In  countries  other  than  the  United  States  and  the  Nether- 
lands, the  protection  provided  for  depositors  by  law  has  been  only 
such  as  is  provided  for  creditors  of  the  bank  in  general — that  is, 
such  protection  as  comes  by  limitations  on  the  loans  and  invest- 
ments and  business  activities  of  the  bank,  by  periodic  examina- 
tions and  careful  supervision  of  the  banks  by  a  state  or  federal 
banking  department,  by  prohibition  of  interlocking  directorates, 
and  so  forth.  As  the  volume  of  deposit  business  in  the  Nether- 
lands is  small,  absolutely  and  relatively  to  the  note  issues,  the 
United  States  may  be  said  to  stand  alone  among  the  deposit- 
banking  countries  in  its  efforts  to  give  special  protection  to  de- 
positors. 

Provision  for  Protection 

Two  methods  of  protection  are  provided  in  the  United  States. 
Both  the  federal  and  state  laws  require  minimum  percentage  re- 
serves to  be  held  against  deposits.  Since  the  state  and  national 
banks  are  competitors,  the  state  reserve  requirements  do  not 

VOL.  I — 9  129 


130  MONEY,  CREDIT,  AND  BANKING 

exceed,  and  are  usually  equal  to  or  less  than,  the  federal  require- 
ments, but  the  plans  are  similar.  The  minimum  percentage  re- 
serve requirements  under  the  National  Bank  Act  and  under  the 
Federal  Reserve  Act,  with  amendments,  along  with  the  good  and 
bad  features  of  the  system,  are  treated  in  Volume  II,  Chapters 
XXI  and  XXII. 

Another  method  is  in  use  in  the  states  of  Oklahoma,  Kansas, 
Nebraska,  Texas,  Mississippi,  South  Dakota,  and  Washington, 
where  provision  is  made  for  the  compulsory  or  voluntary  insur- 
ance, or  "guaranty,"  of  deposits. 

Methods  of  Guaranteeing  Deposits 

In  periods  of  depression  and  panic  in  the  Middle  West,  high 
losses  by  bank  depositors  have  occasioned  legislative  movements 
for  their  protection.  Out  of  the  panic  of  1907  arose  various  plans 
for  the  guaranty  of  deposits,  and  in  1908  Oklahoma  enacted  a 
compulsory  system  of  mutual  guaranty,  which  was  followed  by 
guaranty  legislation  in  the  Dakotas,  Nebraska,  Kansas,  Texas, 
Mississippi,  and  Washington.  The  plans  so  far  tried  are  four  in 
number: 

1.  Voluntary  state-supervised  associations  of  banks  which 

collectively  guarantee  the  deposits  of  the  members  and 
pay  the  depositors  of  a  failed  member  out  of  a  fund  sub- 
scribed to  by  the  members  in  proportion  to  their  aver- 
age guaranteed  deposits. 

2.  State- wide  compulsory  systems  requiring  all  state  banks 

to  pay  regular  and  occasionally  extra  assessments, 
determined  by  the  amount  of  defaulted  deposits  and 
proportional  to  the  average  guaranteed  deposits  of  the 
assessed  banks. 

3.  Systems  permitting  or  requiring  state  banks  to  form 

associations  without  state  supervision  and  mutually 
guaranteeing  their  depositors. 


PROTECTION  OF  DEPOSITORS  I31 

4.  A  system  whereby  some  insurance  or  casualty  company 
enters  into  contracts  with  the  several  banks  to  insure 
the  depositors  of  those  banks  against  loss;  the  premium 
paid  by  such  banks  to  the  insuring  company  varying, 
of  course,  with  the  respective  bank  according  to  the 
factors  of  risk,  such  as  management,  policy,  location, 
financial  record,  and  so  forth.  For  the  most  part  de- 
posits are  a  bad  form  of  risk,  are  not  actuarially  pre- 
dictable, and  require  too  constant  supervision  by  the 
insuring  company.  Only  two  companies  are  known  to 
the  author  that  handle  such  insurance  at  present.  This 
form  of  guaranty  is  entirely  independent  of  state  action. 

Safety  Fund  Plan 

The  first  application  of  the  safety  fund  plan  to  protect  deposits 
was  in  the  form  of  a  bank  law  in  New  York  State  in  1829,  though 
the  apparent  intention  of  the  legislature  was  to  guarantee  notes 
only.  After  a  near  failure  of  the  scheme,  because  of  the  inade- 
quacy of  the  fund  to  protect  both  notes  and  deposits,  its  applica- 
tion to  deposits  was  abandoned  in  1837.  The  heavy  bank  failures 
during  the  depression  after  the  panic  of  1893  injected  into  the 
more  general  Populist  movement  of  the  mid- west  states  a  demand 
for  the  guaranty  of  deposits.  Only  the  returning  prosperity  after 
1898  stemmed  the  inauguration  of  the  system  in  Kansas  and 
Nebraska  at  that  time. 

The  next  demand  for  guaranty  of  deposits  was  occasioned  by 
the  panic  of  1907,  which  broke  October  22.  When  Oklahoma  be- 
came a  state  on  November  16,  1907,  an  effort  was  made  to  put 
deposit  guaranty  into  the  Oklahoma  constitution,  but  the  at- 
tempt was  killed  in  committee.  On  December  17,  however,  the 
bank  guaranty  law,  to  go  into  effect  in  sixty  days,  was  passed  as 
the  second  act  of  the  first  legislature.  The  frontier  is  "pre- 
eminently the  land  of  sanguine  radicalism  and  experimental 
legislation,"  and  more  subject  to  what  Brice  has  called  "legisla- 


132  MONEY,  CREDIT,  AND  BANKING 

tive  temerity"  and  extreme  "confidence  in  the  power  of  the  state" 
than  the  older  and  more  conservative  states.  The  idea  of  guaran- 
teeing deposits  proved  very  popular  and  was  at  once  seized  upon 
by  the  political  parties  as  political  capital.  It  was  adopted  by  the 
Democratic  Convention  at  Denver,  in  1908,  as  a  plank  in  the  na- 
tional platform,  and  in  Kansas  the  same  year  the  Republicans 
bolted  their  own  national  platform  and  declared  for  deposit 
guaranty.  In  1909,  deposit  guaranty  laws  were  passed  alike  in 
Kansas  and  North  Dakota,  Republican  states,  and  in  Texas  and 
Nebraska,  Democratic  states.  The  political  nature  and  execution 
of  the  laws  have  been  to  a  large  degree  responsible  for  the  poor 
working  of  the  plan. 

The  Oklahoma  System 

By  the  Act  of  December  17,  depositors  of  defaulting  Okla- 
homa banks  were  to  be  paid  at  once;  and  to  provide  a  fund  in 
advance  to  meet  such  contingent  payments,  assessments  were 
levied  against  all  state  banks  and  trust  companies  equal  to  1  per 
cent  of  their  average  daily  deposits.  This  fund,  when  depleted  by 
payments,  was  to  be  repleted  by  special  assessments  to  which  no 
limit  was  set.  By  the  amendment  of  1909  the  fund  was  fixed  at 
5  per  cent  of  the  average  daily  deposits  and  was  to  be  gradually 
accumulated  by  contributions  of  yi  per  cent  per  year.  In  19 13 
the  extra  assessments  in  any  one  year  were  limited  to  2  per  cent. 

The  present  status  of  the  law  is  that  the  annual  assessment 
shall  be  }i  per  cent  of  the  average  daily  deposits  and  no  more. 
Extra  assessments  were  abolished  in  191 6.  In  case  the  fund 
proves  insufficient  at  any  time  to  meet  the  losses,  the  unsatisfied 
depositors  are  given  certificates  of  indebtedness  bearing  6  per 
cent  interest,  or  the  certificates  are  sold  on  the  market  and  the 
proceeds  used  to  pay  depositors.  These  certificates  are  called 
and  paid  as  soon  as  the  legal  annual  assessments  recoup  the  guar- 
anty fund.  They  are  a  first  lien  against  the  assets  of  each  bank 
operating  under  the  law  to  the  extent  of  the  bank's  liability  to 


PROTECTION  OF  DEPOSITORS  133 

the  guaranty  fund,  and  are  exempted  from  state  and  local  taxes. 
They  are  considered  a  good  investment  and  have  found  a  ready 
market.  Since  1909,  75  per  cent  of  the  fund  may  be  invested  in 
state  warrants  and  similar  securities,  the  remainder  being  held 
by  the  State  Banking  Board.  Banks  may  pay  their  assessments 
by  non-interest-bearing  cashier's  checks,  and  these  checks  may  be 
held  by  the  board  until  the  funds  are  needed,  thus  giving  the 
contributing  bank  use  of  the  funds  until  really  wanted  by  the 
board. 

To  secure  its  liability  to  the  fund,  the  bank  is  required  to  de- 
posit collateral  securities  equal  to  1  per  cent  of  its  deposits.  The 
State  Banking  Board,  which  handles  this  fund  as  well  as  the 
general  supervision  of  the  banks,  was  at  first  composed  wholly 
of  political  appointees;  but  in  1913  the  banks  succeeded  in  getting 
control  of  appointments  to  the  board  to  the  extent  that  three  of 
its  five  members  are  now  chosen  from  a  list  recommended  by  the 
State  Bankers'  Association.  When  a  bank  defaults,  the  State 
Bank  Commissioner  takes  charge  and  determines  whether  it  is 
solvent  or  not;  if  he  finds  it  insolvent  he  liquidates  it.  Deposi- 
tors are  paid  from  the  available  cash  and  from  the  guaranty  fund ; 
the  proceeds  from  the  liquidation  are  paid  into  the  fund,  but  if 
insufficient  to  replete  it,  certificates  of  indebtedness  are  issued  to 
the  unsatisfied  depositors  or  are  sold  to  the  public  at  large  for 
funds  to  pay  depositors.  Deposits  that  are  otherwise  secured  are 
not  guaranteed,  nor  are  deposits  guaranteed  on  which  a  greater 
rate  of  interest  is  paid  than  that  fixed  by  the  Bank  Commissioner 
(4  per  cent  in  1 918),  nor  are  deposits  of  trust  companies  protected 
any  longer. 

Unfavorable  Conditions  in  Oklahoma 

For  certain  reasons,  conditions  have  not  been  favorable  for 
experimentation  with  deposit  guaranty  in  Oklahoma.  For  one 
thing,  despite  the  fact  that  the  banks  of  Indian  Territory,  which 
became  part  of  Oklahoma  upon  its  admission  to  statehood,  had 


134  MONEY,  CREDIT,  AND  BANKING 

never  had  state  supervision,  and  those  of  Oklahoma  Territory 
not  perfect  supervision,  they  were  forced  into  the  guarantee 
system  with  a  very  superficial  examination  as  to  their  solvency 
and  practices.  Political  expediency  rather  than  financial  fitness 
weighed  too  heavily  as  credentials  for  entering.  The  risks  were, 
therefore,  not  selected  with  caution  from  the  very  first. 

Then,  too,  national  banks,  although  permitted  to  join  by 
terms  of  the  law,  were  denied  the  right  to  join  by  opinion  of  the 
Comptroller  of  the  Currency  and  the  Attorney- General,  on 
several  counts.  To  enter  the  system,  therefore,  national  banks 
had  to  surrender  their  national  charters  and  become  state  banks. 
This  was  expensive  and  bothersome  and  was  done  reluctantly. 
The  large  banks  were  national  banks  and  were  in  the  larger  cities; 
the  state  banks  were  of  varying  sizes  and  more  scattered.  The 
law,  therefore,  affected  areas  differently. 

In  addition,  and  almost  inevitably,  the  law  at  once  became 
the  football  and  tool  of  political  parties.  To  make  the  law  work 
successfully,  high-handed  methods  were  resorted  to  and  criminal 
bank  officials  were  left  unpunished.  The  evils  from  its  political 
administration  were  much  reduced,  however,  when  in  19 13  the 
State  Bankers'  Association  secured  representation  on  the  State 
Banking  Board. 

The  law  was  hastily  drawn,  without  precedent  to  guide,  and 
enacted  by  a  new  legislature,  in  a  new  state,  without  debate,  and 
put  into  operation  in  an  unduly  short  time — all  in  the  midst  of  a 
financial  panic  when  judgment  was  warped  by  public  clamor. 
The  result  was  a  poor  law,  difficult  of  execution,  and  requiring 
many  amendments. 

The  state  had  been  and  was  in  the  throes  of  speculation  and 
bank  officials  were  active  in  speculative  ventures ;  the  real  estate 
boom  and  the  oil  boom  were  led  or  facilitated  by  the  bankers. 
Bank  credit  was  unduly  extended  on  tenuous  security.  The  state 
was  new,  was  growing  at  unprecedented  rates  into  great  agricul- 
tural, oil,  and  lumber  wealth.    Speculation,  venturesomeness,  and 


PROTECTION  OF  DEPOSITORS  135 

dishonesty  were  rampant;  banks  do  best  when  nurtured  in  a  more 
conservative  soil.    Bank  morals  were  very  lax. 

There  was  a  high  concentration  of  risks.  The  guaranty  sys- 
tem was  in  operation  in  only  a  single  state,  which  outside  its  oil 
production  was  almost  wholly  agricultural,  and  as  a  result  a 
crop  failure  such  as  fell  upon  the  state  in  191 1  shook  the  bank- 
ing structure  with  great  severity.  Besides,  there  was  a  great  con- 
centration of  bank  credit  in  Oklahoma  City.  Had  the  guaranty 
system  been  nation-wide  there  would  have  been  prosperous  states, 
areas,  and  industries  to  compensate  for  the  defaulting  states,  areas, 
and  industries,  and  the  financial  world  would  have  had  a  more 
even  tenor. 

Popularity  of  the  System 

The  Oklahoma  system  was  from  the  first  very  popular.  Until 
191 1,  the  state  banks  increased  fast  in  number  and  deposits, 
while  the  national  banks  declined  in  number  and  increased  their 
deposits  but  slightly.  The  crop  failure  of  191 1 ,  however,  precipi- 
tated a  financial  crash;  the  speculative  boom  collapsed  and 
dragged  many  banks  into  insolvency.  The  assessments  to  pro- 
vide and  maintain  the  guaranty  fund  became  very  onerous. 
Reduced  to  a  percentage  of  the  average  capitalization  of  the 
banks  for  these  years,  the  guaranty  system  cost  the  banks  rather 
more  than  3  per  cent  annually.  The  heavy  burden  in  191 1  and 
191 2  led  to  the  desire  for  escape  from  the  guaranty  system,  an 
escape  which  nationalization  offered  to  those  banks  that  had 
sufficient  capitalization.  Hence  practically  all  the  larger  banks 
and  those  in  the  large  cities  became  national  banks,  leaving  with- 
in the  guaranty  system  only  those  banks  that  had  too  small  a 
capitalization  to  become  national  banks. 

The  Kansas  System 

Owing  to  the  general  popularity  of  deposit  guaranty,  and  par- 
ticularly to  the  pressure  brought  by  banks  of  Kansas  near  the 


136  MONEY,  CREDIT,  AND  BANKING 

Oklahoma  line,  which  felt  a  migration  of  deposits  to  the  guaran- 
teed Oklahoma  banks,  the  Kansas  legislature  (Republican)  in 
1909  enacted  a  guaranty  law.  Some  of  the  salient  features  of  the 
Kansas  plan  are  these. 

The  system  is  voluntary;  any  incorporated  bank,  a  year  old 
and  having  a  10  per  cent  surplus  paid  up  and  unimpaired,  may 
join,  but  before  admission  it  is  subjected  to  a  rigid  examination 
by  the  State  Bank  Commissioner,  and  as  evidence  of  good  faith 
it  is  required  to  deposit  $500  in  cash  or  in  national,  state,  or 
municipal  bonds  for  every  $100,000  of  deposits.  The  state  does 
not  attempt  to  pay  depositors  cash  immediately  upon  default 
of  the  bank,  but  issues  certificates  of  indebtedness  bearing  6  per 
cent  interest.  It  then  liquidates  the  bank  and  applies  the  pro- 
ceeds in  payment  of  the  outstanding  certificates.  These  certi- 
ficates are  regarded  as  a  good  investment  and  are  particularly 
sought  after  by  the  banks  as  a  means  of  getting  new  customers. 

Provision  is  made  for  contributions  to  a  fund  large  enough 
to  cover  the  ultimate  losses,  for  immediate  payment  of  deposits  is 
not  made.  The  law  fixes  the  annual  assessment  at  -£■$  per  cent  of 
the  average  daily  deposits,  less  capital  stock  and  surplus;  this 
exemption  fosters  higher  capitalization  and  the  accumulation  of 
surplus.  These  annual  assessments  continue  until  the  fund 
reaches  $500,000,  when  they  cease.  Thereafter  special  assess- 
ments of  uV  per  cent  may  be  made  to  replenish  the  fund  when  it 
is  depleted  by  payment  of  losses — not  more  than  five  such  assess- 
ments, however,  being  made  in  any  one  year.  The  fund  is  held 
by  the  State  Treasurer.  Any  bank  is  permitted  to  withdraw  at 
will,  but  it  must  pay  its  quota  of  the  assessments  to  cover  losses 
occurring  within  the  succeeding  six  months. 

Strength  of  Kansas  System 

The  Kansas  law  has  many  elements  of  strength  not  found 
in  the  original  Oklahoma  law.  The  chief  advantages  are  the 
following: 


PROTECTION  OF  DEPOSITORS  137 

i.  Undue  expansion  of  deposits  is  checked  by  limiting  them 
to  ten  times  the  capital  of  the  bank. 

2.  The  rate  of  interest  paid  on  deposits  guaranteed  by  the 

system  is  limited. 

3.  Banks  are  prohibited  from  advertising  that  their  deposits 

are  protected  by  the  state. 

4.  Entering  banks  are  rigidly  examined. 

5.  Banks  must  be  a  year  old  and  have  accumulated  a  10 

per  cent  surplus. 

6.  The  accumulation  of  surplus  and  the  contribution  of  a 

large  capital  are  encouraged. 

7.  The  Bank  Commissioner  has  power  to  remove  incompe- 

tent, reckless,  or  dishonest  bank  officials. 

8.  The  maximum  time  allowed  a  bank  to  correct  any  abuses 

the  Bank  Commissioner  orders  corrected  is  thirty 
days. 

9.  The  amount  of  the  assessment  is  low  and  is  strictly  limited. 
10.  The  law  is  supplemented  by  a  better,  older,  and  more 

exacting  system  of  bank  supervision  than  existed  in 
Oklahoma. 

The  Kansas  act  went  into  effect  June  30,  1909.  Since  then 
the  number  of  guaranteed  banks  has  increased  gradually,  and  on 
June  30,  1916,  was  539  to  448  non-guaranteed.  On  that  date  the 
guaranteed  banks  had  about  twice  the  deposits  of  the  non-guaran- 
teed, the  larger  banks  having  joined  and  the  newer  and  smaller 
banks  being  excluded  by  the  requirement  of  a  10  per  cent  surplus. 
Only  one  guaranteed  bank  had  failed  to  date,  and  this  failure  was 
due  to  reasons  other  than  the  existence  of  the  guaranty  law.  In 
March,  192 1,  the  number  of  banks  operating  under  the  guaranty 
law  had  reached  694  out  of  a  total  of  1,107  state  banks. 

The  state  banks  of  Kansas  having  adopted  guaranty  of  de- 
posits, the  national  banks  of  that  state  were  constrained  to  meet 
the  competition.  Since  they  were  denied  the  right  to  join  the 
Kansas  system,  they  organized  in  1909  the  Kansas  Bankers' 


138  MONEY,  CREDIT,  AND  BANKING 

Deposit  Guaranty  and  Surety  Company.  This  company,  capital- 
ized at  $500,000,  is  owned  by  bank  officers  of  the  national  banks 
and  those  state  banks  that  did  not  join  the  Kansas  system.  Its 
head  office  is  at  Topeka.  It  issues  policies  to  each  member  bank 
guaranteeing  the  deposits  in  case  of  bank  failure;  the  premium 
rates  are  50  cents  per  thousand  dollars  of  deposits  up  to  the 
amount  of  the  capital  and  surplus,  and  $1  per  thousand  dollars  of 
deposits  in  excess  of  capital  and  surplus.  About  a  hundred  banks 
took  out  policies.  As  there  have  been  no  losses,  the  demand  for 
guaranty  has  declined,  and  many  of  the  banks  have  let  their 
policies  lapse.  The  company  now  does  a  bonding,  surety,  and 
guaranty  business  in  several  lines. 

Arguments  for  Guaranty  of  Deposits 

Argument  in  favor  of  guaranteeing  deposits  has  been  on 
political,  moral,  social,  and  economic  grounds.  The  political 
(largely  partizan)  arguments  may  be  waived,  except  to  remark 
that  if  deposit  guaranty  brings  greater  economic  and  financial 
and  therefore  political  stability  it  may  be  very  desirable  in  our 
country,  where  things  economic  and  financial  unfortunately  are 
only  too  often  turned  to  bad  uses  by  politicians.  The  moral 
obligation  of  a  banker  to  pay  depositors  is  unquestioned,  but  the 
standing  policy  of  our  bankrupt  laws  is  to  excuse  the  legal  obliga- 
tion under  certain  warrantable  conditions;  the  guaranty  of  credi- 
tors of  a  banker  by  the  state  must  rest,  therefore,  on  exceptional 
reasons. 

One  such  argument  frequently  used  in  favor  of  guaranteeing 
deposits  is  that  banks  are  created  (chartered)  by  the  state  and 
entrusted  with  great  public  functions,  such  as  the  issue  of  cur- 
rency and  the  keeping  and  transfer  of  public  funds,  and  that  the 
state,  in  consequence  of  its  rigid  supervision  of  banks,  clothes 
them  with  a  fictitious  credit  and  by  implication  warrants  the 
public  against  abuse  of  bank  credit  extensions.  In  contravention 
of  this  argument  for  particularizing  the  guaranty  of  bank  credi- 


PROTECTION  OF  DEPOSITORS  139 

tors,  it  may  be  said  that  government  supervision  does  not  neces- 
sarily imply  a  guaranty  of  the  credit  of  the  supervised  institution, 
a  fact  which  the  public  may  be  presumed  to  know.  Moreover  all 
corporations — not  banks  alone — are  created  by  the  state,  and 
many  corporations  other  than  banks  are  clothed  with  that  credit 
which  springs  from  government  supervision,  and  are  endowed 
with  such  powers  as  make  them  public  utilities.  Furthermore 
the  government  itself  takes  precautions  to  guard  any  funds  it 
may  place  with  the  banks. 

On  the  other  hand,  there  is  in  all  probability  no  corporate 
activity  whose  soundness  and  stability  so  permeate  and  affect 
the  financial,  economic,  and  social  situation  as  does  banking. 
A  panic  halts  everything  and  brings  about  unrest;  and  because 
deposit  credit  is  so  important  in  our  national  life,  because  govern- 
ment supervisors  and  examiners  cannot  fully  guard  against  fraud, 
dishonesty,  and  poor  judgment  of  bankers,  and  because  deposi- 
tors lack  ability  to  pick  sound  banks  or  place  their  funds  else- 
where and  are  helpless  to  protect  themselves,  the  state  may  be 
justified  in  going  further  than  simply  to  supervise ;  it  may  actually 
guarantee  the  deposits. 

Effect  of  Guaranty  on  Panics 

The  degree  of  stability  that  can  be  achieved  by  deposit  guar- 
anty applies  to  runs  on  banks  rather  than  to  financial  crises. 
Crises  depend  upon  more  comprehensive  causes  than  the  con- 
fidence of  depositors  in  their  banks,  and  are  brought  about  by 
such  means  as  cyclical  industrial  movements,  wars,  earthquakes, 
rainfall,  and  so  forth.  Yet  a  favorite  argument  for  deposit 
guaranty  has  been  the  prevention  of  panics.  Panics  are  precipi- 
tated by  want  of  bank  "accommodation";  loans  on  which  the 
maintenance  of  existing  business  or  the  completion  of  projected 
business  depend,  cannot  be  secured.  Against  such  a  situation, 
deposit  guaranty  offers  no  protection.  If  a  bank  has  reached  its 
legal  limit  of  loans,  the  guaranty  of  deposits  does  not  remove 


140  MONEY,  CREDIT,  AND  BANKING 

that  limit.  In  fact,  as  will  appear  below,  the  deposit  guaranty 
may  cause  overexpansion  and  speculation,  and  promote  the 
development  of  industrial  and  financial  panics.  It  does,  however, 
prevent  runs  on  banks,  or  at  least  make  them  less  panicky,  and 
may,  therefore,  prevent  the  closing  of  sound  banks  by  runs  and 
in  this  way  add  to  the  general  credit  stability. 

Some  of  the  most  remarkable  failures  of  guaranteed  banks  in 
Oklahoma  scarcely  disturbed  the  general  business  confidence. 
Depositors  were  quite  indifferent  about  getting  their  deposits 
before  the  bank  closed,  and  those  withdrawn  were  immediately 
redeposited  in  other  banks  in  the  same  city.  Where  deposit 
guaranty  is  in  effect,  the  ordinary  confusion  and  rush  attending  a 
bank  failure  are  absent,  for  the  depositors  know  that  their  de- 
posits are  safe  and  that  no  advantage  is  gained  by  hurried  demand 
on  the  bank. 

Guaranty  of  Savings  Deposits  and  Commercial  Deposits 

Many  of  the  arguments  for  deposit  guaranty  start  from  the 
point  of  guaranteeing  deposits  that  originate  through  the  deposit 
of  actual  cash  or  cash  items,  that  is,  primarily  savings  deposits, 
and  pass  by  confused  steps  to  guaranteeing  all  deposits.  It  is 
alleged  that  vast  funds  are  now  hoarded  by  people  suspicious  of 
banks  and  that  these  funds  would  be  put  into  banks  if  deposits 
were  guaranteed.  If  the  argument  is  one  of  safety  it  is  answered 
by  the  postal  savings  banks  and  the  war  savings  stamps.  Some 
eccentric  persons  or  foreigners  may  be  influenced  by  guaranteeing 
deposits,  but  the  increase  of  deposits  from  this  source  would 
probably  be  small.  The  argument  applies  primarily  to  savings 
deposits,  and  in  general  deposit  guaranty,  as  operating  in  the 
several  states,  applies  only  to  commercial  deposits.  The  repeated 
proposal  of  the  Comptroller  of  the  Currency  to  guarantee  de- 
posits of  every  depositor  up  to  $5,000  also  springs  from  the 
desire  to  prevent  individual  distress  among  the  small  depositors 
of  savings. 


PROTECTION  OP  DEPOSITORS  141 

Effect  of  Guaranty  on  Banks 

The  sponsors  of  deposit  guaranty  maintain  that  banks  ul- 
timately pay  dearly  for  all  losses  to  depositors,  because  failure 
causes  such  discredit  and  suspicion  and  consequent  falling  off  in 
business,  that  in  one  year  banks  lose  more  than  it  would  cost  to 
maintain  a  safety  fund  for  many  years.  These  losses  come  to 
banks  that  are  prudently  managed  as  well  as  to  those  under  sus- 
picion. To  protect  bank  deposits  in  1 914-19 15,  clearing  house 
loan  certificates  costing  6  per  cent  interest  or  more  were  taken 
out,  and  the  government  made  nearly  $3,000,000  on  the  emer- 
gency currency  issued;  at  present  the  rediscount  rate  is  somewhat 
of  the  same  nature.  It  cannot  be  assumed,  however,  that  these 
costs  would  be  wholly,  if  at  all,  obviated  by  deposit  guaranty. 

Bankers  maintain  that  the  additional  earnings  from  in- 
creased deposits  and  business  would  not  be  nearly  enough  to 
sustain  the  burden  of  deposit  guaranty,  and  that  the  actual  losses 
to  depositors  from  bank  failures  are  too  small  to  warrant  so  drastic 
a  remedy.  The  losses  of  national  bank  depositors  from  1881  to 
191 7  were  $77.5  million,  and  the  average  percentage  of  losses  of 
depositors  to  total  deposits  each  year  for  that  period  was  .023 
per  cent.  The  losses  for  191 7  were  $369,000  out  of  total  deposits 
of  $12,769  million.  Were  failures  not  concentrated  in  certain 
years  and  often  in  limited  localities,  the  answer  that  the  losses 
after  all  are  inconsiderable  and  do  not  warrant  the  expense  of 
maintaining  a  guaranty  fund,  would  suffice.  It  is  the  individual 
distress  of  an  unwitting  depositor,  however,  that  calls  for  help. 

Probably  the  most  telling  argument  brought  against  deposit 
guaranty  is  that  it  puts  all  bankers  on  the  same  level,  making  the 
deposits  in  new,  inexperienced,  reckless,  or  dishonest  banks  as 
safe  as  deposits  in  old,  proved,  conservative,  and  honest  banks; 
removing  all  incentive  for  developing  good- will  and  reputation  for 
sound  banking  and  for  accumulation  of  substantial  surpluses; 
making  liberality  in  extension  of  loans  and  payment  of  interest 
on  deposits  the  chief  inducements  to  depositors;  taxing  good, 


142  MONEY,  CREDIT,  AND  BANKING 

competent,  experienced,  trained,  and  conservative  bankers  in 
order  to  pay  the  losses  wrought  by  the  incompetent,  inexperienced , 
untrained,  and  reckless  bankers;  giving  the  unscrupulous  and 
reckless  banker  the  competitive  advantage  and  thereby  lowering 
the  personnel  of  the  banking  world;  and,  finally,  stimulating  the 
establishment  of  new,  small,  and  speculative  banks  since  they 
(at  least  in  Oklahoma)  are  as  safe  as  the  old,  well-established  in- 
stitutions. 

This  argument  is  largely  personal  and  is  offered  by  the  older, 
better,  bigger  banks,  which  naturally  do  not  wish  to  be  put  on 
a  level  with  the  other  institutions.  It  ignores  the  point  of  view  of 
society,  which  rises  above  personal  advantages  and  weighs  de- 
posit guaranty  as  to  its  net  balance  for  good  or  evil  in  society  as  a 
whole. 

This  argument  is  also  much  weakened  by  comparison  with 
the  actual  facts  of  deposit  guaranty.  Depositors  have  small 
knowledge  and  ability  to  pick  the  safest  banks,  and  rely  largely 
on  government  supervision;  bank  supervision  tends  to  reduce 
bankers  to  the  same  level,  and  the  more  severe  the  supervision  the 
more  nearly  do  they  approach  the  same  level.  In  Oklahoma, 
where  deposit  guaranty  is  in  operation,  the  large  majority  of  de- 
posits are  in  non-guaranteed  banks.  In  Kansas,  which  also  has 
deposit  guaranty,  the  banks  find  little  reason  for  guaranteeing 
deposits  in  order  to  get  or  hold  accounts.  The  banks  are,  not  in 
fact,  therefore  reduced  to  the  same  level,  and  the  banker's 
reputation  still  counts.  Most  depositors  are  at  some  time  or  other 
borrowers  at  their  banks,  and  they  deposit,  therefore,  where 
they  are  best  known,  with  the  idea  of  having  a  dependable  line  of 
accommodation . 

It  is  likewise  difficult  to  show  that  the  actual  effect  of  a  guar- 
anty law  has  been  to  lower  the  banking  personnel;  if  the  bank 
supervision  is  made  stringent  enough  under  the  law,  reckless  and 
fraudulent  banking  will  not  develop,  and  it  may  raise  rather  than 
lower  the  banking  personnel.    In  fact,  an  objection  often  raised 


PROTECTION  OF  DEPOSITORS  143 

against  deposit  guaranty  is  that  there  is  a  real  or  supposed  neces- 
sity of  accompanying  the  establishment  of  the  guaranty  system 
with  the  grant  of  almost  absolute  power  to  the  state  banking 
departments.  In  Canada  and  England,  where  note  issue  is  free, 
the  banks  bring  pressure  to  bear  on  any  bank  which  extends 
credit  dangerously,  the  Canadian  Bankers'  Association,  by  notify- 
ing an  offending  bank  that  it  is  issuing  notes  too  freely,  the  Lon- 
don banks,  by  discriminating  against  the  acceptances  of  an  over- 
extended institution.  It  may  be  that  in  time  the  guaranteed 
banks  will  undertake  such  a  mutual  guardianship,  but  up  to  the 
present  time,  far  from  exercising  a  constant  surveillance  over 
each  other,  they  are  only  too  prone  to  overlook  reckless  and 
criminal  banking.  Where  deposit  guaranty  is  in  operation 
government  officials,  for  political  reasons,  often  fail  to  prosecute 
offending  bankers,  particularly  when  the  bank  guaranty  law  is 
sponsored  by  the  political  party  in  power,  which  naturally  desires 
to  make  the  law  at  least  apparently  successful.  The  public  also 
becomes  less  hostile  to  defaulting  bankers  and  accepts  more  read- 
ily the  justification  of  such  bankers,  since  the  depositing  public 
loses  no  money  under  the  system.  The  net  result  is  that  the  con- 
viction of  bank  officials  under  the  deposit  guaranty  system  is  more 
difficult.  To  keep  the  public  interested  in  the  prosecution  of 
offending  bankers,  it  has  been  proposed  to  levy  general  taxes  to 
provide  part  of  the  guaranty  fund. 

Guaranty  as  Assessment  Insurance 

Guaranty  of  deposits  is  also  objected  to  on  the  ground  that 
it  is  a  form  of  assessment  insurance,  is  not  actuarial,  does  not  se- 
lect risks,  and  suffers  from  a  high  concentration  of  risks.  It  is 
true  that  guaranty  of  deposits  is  a  sort  of  assessment  insurance, 
but  it  is  without  the  defects  of  such  insurance.  If  it  were  made 
compulsory  on  all  banks,  the  danger  of  the  survivor  being  bur- 
dened and  uninsured  would  not  apply;  and  if,  under  a  volun- 
tary plan,  a  withdrawing  bank  should  be  held  to  pay  losses  arising 


144  MONEY,  CREDIT,  AND  BANKING 

for,  say,  six  months  afterwards,  and  if  the  amount  of  the  assess- 
ments were  strictly  limited,  the  above  danger  would  be  mini- 
mized. Besides,  the  risk,  instead  of  increasing  with  the  age  of 
the  insured  bank,  would  normally  decrease  as  the  bank  matures, 
becomes  conservative,  and  accumulates  a  surplus.  Bank  failures 
do  tend  to  concentrate  in  periods  of  depression  and  in  industrial 
areas;  there  is  not,  and  cannot  be,  the  dispersion  of  risks  among 
many  banks  of  different  types,  particularly  if  the  guaranty  system 
applies  to  banks  of  a  single  state,  nor  can  there  be  a  classification 
and  selection  of  risks  and  an  adjustment  of  premium  according  to 
risks,  when  the  system  applies  to  all  banks.  The  necessity  of  a 
strict  supervision  to  reduce  the  banks  to  uniformity  of  risk  is 
therefore  evident,  as  is  the  necessity  of  a  strict  examination  of  the 
candidate  bank  before  admitting  it  to  the  system. 


CHAPTER  IX 
RESERVES  FOR  PROTECTION  OF  BANK  CREDIT 

Considerations  Governing  Size  of  Cash  Reserve 

In  Chapter  VI  it  was  stated  that  one  of  the  three  essential 
objectives  in  protecting  bank  notes  is  to  provide  for  their  instant 
convertibility  upon  demand  by  the  holder  and  thus  maintain 
their  parity.  The  same  applies  to  demand  deposits,  if  checks  and 
sight  drafts  are  to  be  kept  at  par. 

The  problem  is  to  keep  on  hand  or  within  reach  sufficient  cash 
to  meet  not  only  ordinary  but  extraordinary  demands.  The  sum 
kept  for  meeting  the  ordinary  demand  is  spoken  of  as  "till 
money,"  or  "cash,"  and  that  for  meeting  the  extraordinary  is 
called  "reserve  money."  "Reserve"  is  sometimes  used  to  cover 
both  sums.  The  till  money  may  be  in  any  form;  the  reserve 
should  consist  only  of  legal  tender  or  standard  money.  The 
amounts  that  must  be  kept  for  these  purposes  are  determined  by 
experience  and  the  conservatism  of  the  banker.  A  bank  with 
relatively  few  depositors,  or  with  a  few  exceptionally  large  deposi- 
tors, must  be  cautious  and  maintain  larger  reserves  than  banks 
with  a  large  body  of  relatively  equal  depositors.  A  bank  with  a 
large  body  of  foreign-born  or  ignorant  and  excitable  depositors 
must  fortify  itself  against  precipitate,  unreasoned  runs;  a  bank  in 
a  large  city  needs  higher  reserves  than  banks  in  smaller  centers  or 
rural  districts.  A  banker  who  is  conservative,  preferring  safety 
to  great  earnings,  and  who  feels  a  high  sense  of  responsibility  to 
the  community,  will  keep  higher  reserves  than  one  not  so  scrupu- 
lous. A  bank  which  has  good  business  relations  with  a  large  cen- 
tral bank,  or  which  stands  well  with  the  other  banks  of  the  city, 
and  which  can,  therefore,  in  emergency  borrow  or  rediscount, 
may  safely  carry  lower  reserves.    The  reserves  against  demand 

VOL.  I  — 10  145 


146  MONEY,  CREDIT,  AND  BANKING 

liabilities  need  to  be  higher  than  against  time  liabilities,  since 
advance  notice  may  be  required  in  the  case  of  time  liabilities,  and 
the  maturities  being  known,  provision  against  their  liquidation 
can  be  made.  Finally  a  bank  with  a  good  secondary  reserve 
which  can  be  liquidated  in  emergency  need  carry  only  small 
reserves. 

The  proper  reserve  has  to  be  determined,  therefore,  by  each 
bank  for  itself  in  the  light  of  these  and  other  controlling  condi- 
tions. The  penalty  of  expansion  on  too  slender  reserves  is  to 
incur  adverse  clearing  house  balances;  the  percentage  of  reserve, 
as  among  the  banks  of  a  system,  cannot  vary  to  a  great  extent 
with  impunity.  The  state  may  determine  upon  some  proportional 
reserve  which,  in  the  light  of  average  experience  to  date,  seems 
to  provide  a  normal  degree  of  safety,  and  prescribe  this  as  a 
minimum,  and  close  or  penalize  banks  which  continually  tres- 
pass on  this  minimum.  This  has  been  the  practice  in  the  United 
States  with  respect  to  both  notes  and  deposits.  The  banks  are 
expected  to  keep — and  usually  do  keep — larger  reserves  than  this 
minimum. 

Desirability  of  Minimum  Reserve 

It  is  very  questionable  whether  it  is  desirable  to  establish  a 
minimum  reserve  by  law,  though  it  does  exert  a  restraining  in- 
fluence on  a  few  reckless  bankers  who  might  otherwise  injure  the 
whole  financial  fabric.  On  the  other  hand,  the  reservation  of  a 
minimum  amount  renders  the  reserves  impotent  at  the  very 
time  they  should,  and  otherwise  would,  perform  the  service  for 
which  they  are  kept,  namely,  that  of  providing  for  convertibility 
in  emergencies.  Such  a  minimum  gives  the  banker  a  weapon  of 
self-defense,  but  ties  his  hands.  The  psychological  effect  of  the 
known  large  reserve  is  undoubtedly  good,  allaying  the  depositor's 
fears  as  to  the  bank's  ability  to  pay  on  demand;  but  if  the  deposi- 
tor also  realized  that  this  reserve  could  not  be  actually  used  when 
required,  his  faith  would  be  less  strong.    A  further  disadvantage 


RESERVES  FOR  PROTECTING  BANK  CREDIT  147 

of  the  fixed  minimum  reserve  is  that  it  undoubtedly  tends  to 
become  the  maximum  kept  by  the  banks. 

The  banker  steers  his  course  between  two  opposing  tendencies. 
A  cash  reserve  which  bears  a  high  ratio  to  the  demand  liabilities 
promotes  safety  and  high  confidence  in  the  bank;  but  the  bank 
makes  its  profits  on  extensions  of  credit  by  way  of  notes,  deposits, 
and  so  forth,  and  the  lower  the  ratio  of  reserve  to  these  liabilities 
the  greater  the  earnings  of  the  bank.  The  bank  is  a  corporation 
whose  raison  d'etre  is  profits  to  its  stockholders.  The  officers  of 
the  bank  are,  therefore,  moved  to  build  on  the  cash  holdings  of 
the  bank  as  large  a  superstructure  of  credit  as  safety  warrants; 
reckless  extensions  of  loans  bring  dividends  but  invite  disaster. 
In  these  respects  a  bank  differs  in  no  essential  from  any  business 
institution;  a  working  balance  of  cash  is  necessary  to  each;  the 
important  difference  is  one  of  degree.  Demand  liabilities,  in 
contradistinction  to  time  liabilities,  constitute  practically  the 
whole  credit  of  a  bank,  whereas  they  constitute  only  a  small  pro- 
portion of  the  credit  of  other  businesses.  Consequently  the 
greater  importance  of  bank  reserves  is  manifest. 

Methods  of  Increasing  Reserves 

The  cash  reserve  of  a  bank  fluctuates  in  size  according  to  the 
business  transacted,  varying  with  the  hour,  day,  season,  year,  and 
cycle  of  years.  It  is  desirable  that  it  should  fluctuate,  for  rigidity 
would  indicate  that  the  bank  was  not  accommodating  its  cus- 
tomers. This  fluctuation  is  both  absolute  and  proportional. 
Payments  to  the  bank  or  deposits  of  actual  cash  by  customers  in- 
crease the  reserves  proportionally  to  the  liabilities,  whereas  pay- 
ments of  cash  by  the  bank  have  an  inverse  effect.  Unless  there 
are  special  state  regulations  which  apply  to  notes  or  deposits,  it  is 
a  matter  of  little  moment  to  the  bank  whether  it  extends  credit  by 
notes  or  by  deposits,  as  demand  liabilities  of  similar  nature  are 
created  in  either  case.  The  bank,  however,  dislikes  to  pay  out 
lawful  money  which  will  reduce  its  reserve,  force  a  reduction  of  its 


148  MONEY,  CREDIT,  AND  BANKING 

loans,  and  lower  its  profits.  The  problem  of  the  banker  is  to 
keep  his  reserve  in  proportion  to  his  liabilities  and  he  has  many 
devices  for  increasing  it  in  case  of  necessity. 

One  device  is  for  a  bank  to  borrow  from  other  banks,  in  its 
own  or  a  central  city,  on  its  note,  secured  or  unsecured.  Hence 
it  is  important  for  it  to  establish  dependable  relations  with  other 
banks.  The  relation  may  be  founded  upon  voluntary  association 
or  upon  a  centralized  banking  system,  or  the  local  clearing  house 
association  may  function  as  creditor  to  needy  banks,  or  the  reserve 
city  correspondent  may  so  serve.  In  a  centralized  system  the 
central  bank  gives  this  succor  as  a  matter  of  duty. 

A  second  device  for  increasing  a  bank's  reserve  is  to  liquidate 
some  of  its  assets.  The  assets  of  a  business  are  classified  as 
"slow"  and  "quick."  Quick  assets  are  those  which  can  be 
converted  into  cash  quickly  and  easily  in  emergencies,  and  con- 
sist of  high-quality  securities  and  self-liquidating,  short-term, 
commercial  paper,  and  the  like.  Marketability  in  emergency 
implies  a  well-organized  market  for  the  particular  asset,  such 
as  the  stock  exchange  market  for  the  sale  of  stocks  and  bonds. 
The  American  practice  has  been  for  banks  to  carry  in  their 
portfolios  quantities  of  high-class  securities  which  perform  the 
double  function  of  secondary  reserve  and  earning  assets.  Eu- 
ropean banks  favor  commercial  paper  for  their  secondary  re- 
serve, since  their  discount  market  is  well  organized;  in  fact  their 
practice  is  to  keep  their  spare  funds  continuously  invested  in  this 
paper  and  rediscount  freely  with  any  shift  in  the  market.  This 
practice,  though  at  present  less  possible  in  the  United  States, 
where  the  discount  market  is  in  its  infancy,  gives  promise  of 
rapid  extension.  The  dependence  of  our  banking  system  upon 
the  securities  markets  has  too  closely  interrelated  the  commercial 
and  financial  capital  of  the  country  and  has  tended  to  lay  the 
basis  for  panics. 

A  third  device  is  contraction  of  loans.  This  may  be  ac- 
complished through  positive  methods;  that  is,  the  bank  may 


RESERVES  FOR  PROTECTING  BANK  CREDIT  149 

call  for  payment  of  demand  loans.  If  they  are  paid  in  cash, 
the  reserve  will  be  built  up  absolutely.  If  they  are  paid 
with  credits  on  other  banks,  these  may  be  collected  directly  or 
through  the  clearing  house.  If  they  are  paid  in  the  bank's  own 
notes,  one  of  two  things  will  result — if  the  incoming  notes  are 
retired  and  canceled  the  liabilities  will  be  reduced  and  the  propor- 
tional reserve  will  be  restored;  if  the  notes  are  kept  alive  in  the 
cash  of  the  bank  (as  is  the  case  with  national  banks  in  the  United 
States),  the  liabilities  will  remain  as  they  were  and  the  till  money 
will  be  increased. 

Or  the  contraction  may  be  accomplished  through  negative 
methods;  that  is,  the  banker  may  refuse  to  issue  new  loans  or  to 
renew  old  ones  when  they  fall  due.  As  demand  liabilities,  there- 
fore, do  not  increase  while  loans  are  maturing  and  being  paid,  the 
reserve  in  consequence  is  increased  absolutely  and  relatively. 
Such  negative  contraction  may  be  accomplished  without  an  ac- 
tual refusal  to  loan,  merely  by  raising  the  rate  for  bills  offered  for 
discount  to  discourage  discounting.  High  discount  rates  indicate 
low  reserves  and  difficulties  in  getting  loans — the  condition  in 
which  the  market  is  described  as  "tight."  Low  rates  indicate 
high  reserves,  ease  in  getting  loans,  and  an  "  easy"  money  market. 
In  refusing  new  loans  or  renewals  and  in  asking  higher  discount 
rates  the  bank  exercises  discretion — desirable  customers  are 
favored,  particularly  those  who  have  large  accounts,  carry  good 
steady  balances,  and  have  wide  business  influence. 

A  further  method  of  protecting  reserves  is  the  synchronizing 
of  receipts  and  loans.  By  the  careful  selection  of  commercial 
paper  with  respect  to  maturities  a  steady  inflow  of  funds  can  be 
realized,  or  if  business  is  seasonal,  large  inflow  can  be  had  at  the 
times  when  the  demand  for  loans  is  exceptionally  large.  Rather 
than  keep  funds  idle  to  provide  against  a  time  when  it  is  known 
that  the  demand  for  loans  will  be  great,  the  banker  buys  from 
note-brokers  commercial  paper  which  will  mature  at  such 
time. 


150  MONEY,  CREDIT,  AND  BANKING 

Importance  of  Regulating  Cash  Reserve 

So  long  as  a  bank's  officers  realize  their  responsibility  for 
meeting  liabilities  upon  demand,  and  so  long  as  the  government 
authorities  enforce  the  law  and  regulations  to  this  end,  probably 
the  most  important  duty  of  the  officers  is  to  regulate  the  cash 
reserve  so  as  to  be  able  to  meet  the  demands  upon  the  bank.  The 
situation  becomes  dangerous  and  critical  when  the  banks  suspend 
specie  payments  and  the  government  acquiesces  in  such  sus- 
pension. In  times  of  threatened  panic  the  banks  are  wont  to 
appeal  to  their  creditors  to  refrain  from  withdrawing  funds,  the 
argument  being  that  with  a  little  indulgence  in  this  matter  the 
bank  will  be  in  a  safe  position  and  not  be  forced  to  liquidate. 
The  government  may  also  refrain  from  prosecuting  banks  which 
have  suspended  specie  payments  under  such  conditions.  Banks 
thus  operating  under  suspension  of  specie  payments,  being  freed 
from  the  necessity  of  maintaining  cash  reserves,  can  expand  their 
liabilities  without  limitation.  The  requirement  of  a  cash  reserve 
sets  a  physical  limit  to  the  maximum  quantity  of  bank  notes  and 
deposits  issuable  by  a  bank,  such  quantity  being  only  the  legal 
multiple  of  the  reserve.  Under  suspension  the  deposits  and  bank 
notes  arising  from  discounts  "may  be  as  infinite  as  the  range  of 
speculation  and  adventure  in  a  great  commercial  country." 

Essentials  of  Secondary  Reserve 

The  banker  likes  to  have  all  his  assets  earning  profits.  Loans 
and  Discounts  earn  interest  and  discount;  the  Securities  Owned 
yield  interest  or  dividends  and  may  increase  in  value  with  changes 
in  the  market  or  with  the  approach  of  their  maturity  dates ;  por- 
tions of  the  bank  building  may  be  leased  to  outsiders  for  good 
rentals;  the  Due  from  Banks  may  be  earning  2  or  more  per  cent 
on  its  average  amount;  Clearing  House  Items  and  Transits  are 
not  earning  assets,  and  are  therefore  cleared  or  collected  as  fast  as 
possible  and  the  receipts  put  into  earning  forms ;  but  the  Cash  on 
Hand  appears  to  the  banker  an  idle  asset.     Though  the  mainte- 


RESERVES  FOR  PROTECTING  BANK  CREDIT  151 

nance  of  such  idle  funds  is  a  necessity  for  the  bank's  very  existence, 
it  is  a  necessary  evil  which  he  would  minimize. 

Since  the  liabilities  of  a  commercial  bank  are  characteristically 
demand  liabilities,  the  immediate  convertibility  of  the  earning 
assets  is  their  prime  essential.  The  creditors  demand  cash  and  are 
not  satisfied  with  the  delivery  of  securities,  however  excellent. 
To  offer  anything  but  cash  is  a  confession  of  failure.  Therefore 
it  is  the  practice,  even  in  the  final  liquidation  of  an  insolvent  bank, 
to  convert  the  securities  at  market  prices  and  pay  cash  to  claim- 
ants rather  than  to  offer  the  securities  direct.  The  same  holds 
true  of  discount  paper.  Securities  or  purchased  paper,  however 
excellent,  are  no  substitute  for  cash  reserve,  though  the  bank's 
reserve  position  may  be  greatly  fortified  by  their  judicious  selec- 
tion. Such  readily  convertible  assets  constitute  the  bank's 
secondary  reserve. 

Ready  convertibility  depends  upon: 

1.  The  organization  of  the  market  for  the  respective  assets. 

2.  Their  usance. 

3.  Their  self -liquidating  quality. 

Convertible  Forms  of  Earning  Assets 

Though  the  market  for  stocks  and  bonds  is  the  highly  organ- 
ized stock  exchange,  the  term  of  such  securities  is  usually  very 
long  and  they  do  not  rest  upon  commercial  transactions  which 
liquidate  them.  Call  loans  with  stock  exchange  collateral  have 
been  regarded  by  American  banks  as  particularly  liquid  assets. ' 
From  the  point  of  view  of  an  individual  bank,  call  loans  in  ordi- 
nary times  answer  well  the  requirements  of  a  secondary  reserve. 
Failure  of  the  borrower  to  heed  the  call  subjects  the  collateral  to 
immediate  sale.    Collateral  time  loans  are  less  liquid.    The  dis- 


*  "A  Banker  whose  institution  has  loaned  in  the  aggregate  several  billion  dollars  on 
Stock  Exchange  collateral  during  his  incumbency  says  that  he  has  never  had  occasion  to 
question  the  liquidity  of  the  'secondary  reserve. '  The  bank  has  taken  but  one  loss  on  a  call 
loan,  for  S 5,000,  and  that  resulted  from  reluctance  to  sell  the  collateral  while  the  brokers 
were  hopeful  of  being  able  to  ride  the  storm  in  which  they  had  become  involved."  (Annalist, 
March  4,  1918.) 


152  MONEY,  CREDIT,  AND  BANKING 

advantages  of  both  call  and  time  loans  are :  first,  that  the  fear  of 
alienating  a  customer  often  deters  the  call  of  the  loan,  or  the 
refusal  to  renew  the  loan  and  sell  the  collateral;  and,  second,  that 
in  times  of  crisis  the  market  for  securities  contracts  severely  and 
the  collateral  has  to  be  sacrificed  at  such  prices  as  promote  the 
violence  of  panic.  European  banks  rely  less  upon  securities  and 
more  upon  commercial  paper  for  secondary  reserve. 

The  market  for  commercial  paper  is  the  discount  market, 
including  the  central  bank,  and  such  paper  has  short  usance  and  is 
self-liquidating.  The  paper  may  be  additionally  liquid  if  there  is 
no  expressed  or  implied  agreement  to  renew  the  loan  at  maturity, 
and  if  the  borrower,  in  order  to  maintain  the  good-will  of  his 
name,  stands  ready  to  borrow  elsewhere  and  take  up  his  paper — 
even  in  advance  of  its  maturity,  if  the  holder  so  desires.  This 
holds  true  only  of  commercial  paper  bought  in  the  open  market. 
Commercial  loans  to  customers  are  much  less  contractile,  for 
such  customers  may  expect  a  continuance  of  their  loans  and  even 
special  accommodation  in  times  of  crisis.  Therefore,  assuming 
that  the  discount  market  is  as  broad  and  convenient  as  the  securi- 
ties market,  and  that  the  rate  of  interest  (discount)  is  as  high, 
it  appears  that  commercial  paper  answers  the  requirements  of  a 
secondary  reserve  better  than  do  stocks  and  bonds  or  loans  based 
upon  them. 

Liquidity  for  Banking  System  as  a  Whole 

While  in  ordinary  times  an  individual  bank  may  find  com- 
mercial paper,  call  and  time  loans,  and  stocks  and  bonds  readily 
convertible  forms  of  earning  assets,  it  is  usually  true  that  this 
seeming  liquidity  is  rather  the  effect  of  their  movement  among 
banks  than  of  an  actual  reduction  of  the  earning  assets  of  the 
bank  system  as  a  whole.  If  bank  A  converts  securities  by  selling 
them  to  bank  B,  there  is  an  interchange  of  cash  assets  for  securi- 
ties assets;  if  they  are  sold  to  an  individual  X,  who  borrows  funds 
from  bank  B  to  make  the  purchase,  there  is  then  a  secured  promis- 


RESERVES  FOR  PROTECTING  BANK  CREDIT  153 

sory  note  in  B's  assets  instead  of  cash,  and  cash  in  A's  assets 
instead  of  securities.  Only  to  the  degree  (and  it  is  usually  small) 
that  the  cash  is  derived  from  other  than  banks,  is  there  any 
genuine  liquidity  for  the  banking  system  as  a  whole.  In  propor- 
tion as  all  banks  rely  upon  one  form  of  secondary  reserve,  whether 
securities  or  call  loans  or  purchased  paper,  it  becomes  increasingly 
difficult  for  them  to  procure  cash  funds  by  selling  assets. 

It  appears,  therefore,  that  the  ability  of  the  banks  of  the  entire 
system  to  pass  through  a  panic  without  suspension  of  specie  pay- 
ments cannot  be  attained  by  the  possession  of  securities,  pur- 
chased paper,  or  other  earning  assets  which  may  in  theory  but 
cannot  in  fact  be  sold  to  other  institutions,  nor  by  the  contraction 
of  loans,  whether  call  or  time  loans,  secured  or  unsecured.  When 
a  violent  panic  breaks,  every  banking  system,  particularly  the 
decentralized,  has  experienced  the  utter  impossibility  of  defense 
against  suspension  by  such  means  of  liquidation,  though  local  or 
moderate  panics  may  be  averted  or  assuaged. 

In  the  time  of  boom  immediately  preceding  a  panic  the  busi- 
ness world  resists  any  extensive  contraction  of  loans.  Even 
bankers,  moved  by  the  desire  for  profits  as  well  as  the  desire  to 
promote  the  business  enterprises  in  which  their  customers  are 
interested,  are  often  blind  to  the  impending  crisis  or  fearful  lest  a 
contraction  might  itself  precipitate  a  panic.  For  these  reasons 
they  are  hesitant  and  reluctant  to  call  or  refuse  loans.  Therefore 
the  "expansion  generally  proceeds  in  the  absence  of  fortuitous 
events  to  the  acute  stage,  when  financial  disruption  may  be 
avoided  only  by  a  rapid  expansion  of  accommodations,  leaving 
the  liquidation  to  be  automatically  achieved  in  the  period  of 
depression  which  follows."2  In  other  words,  contraction  usually 
follows  rather  than  precedes  a  panic,  and  the  process  after  the 
panic  is  to  liquidate  first  the  financial  (speculative)  loans  and 
then  the  commercial  loans.  The  increased  discount  rate  dis- 
courages all  but  necessitous  borrowers  and  attracts  hoarded  or 

2  Journal  of  Political  Economy,  Vol.  36,  p.  737. 


154  MONEY,  CREDIT,  AND  BANKING 

foreign  funds  and  may  alleviate  the  situation,  but  too  often  such 
relief  does  not  come  until  after  the  panic  has  broken. 

A  central  bank,  moved  by  its  sense  of  public  responsibility 
rather  than  by  a  desire  for  profits,  and  clothed  with  a  legal  or 
generally  acknowledged  control  over  loans  and  discount  rates, 
may  stifle  undue  expansion  at  its  inception  by  raising  the  dis- 
count rate  or  otherwise  discouraging  loans;  when  the  panic  stage 
is  reached,  the  central  bank  can  succor  solvent  needy  banks  with 
accommodation  based  upon  its  unused  reserves  and  stop  the  panic, 
not  by  a  sudden  contraction  or  liquidation  but  by  an  expansion 
of  loans  to  be  slowly  contracted  after  the  panic  stage  is  passed. 

Effect  of  War  on  Liquidity  of  Assets 

The  recent  war  has  had  the  effect  of  reducing  the  liquidity  of 
bank  assets  the  world  over.  Forced  by  the  government  or  by 
popular  pressure  to  facilitate  the  financing  of  the  war,  the  banks 
bought  large  quantities  of  government  securities,  they  loaned 
heavily  on  pledges  of  government  securities,  and  in  certain  coun- 
tries they  bought  stocks  in  different  enterprises.  The  result 
today  is  that  their  earning  assets  consist  unduly  of  long-term 
forms  of  paper  and  of  short-term  paper  secured  by  long-term 
bonds. 

Commercial  banking  capital  has  been  diverted  to  financial 
operations  to  an  undesirable  degree.  As  the  situation  when  the 
central  banks  are  laden  with  non-liquid  assets  is  particularly 
undesirable,  the  recovery  of  their  former  liquidity  will  be  one  of 
the  major  aims  of  commercial  banks  during  the  coming  decade. 

Protection  of  Acceptances  and  Letters  of  Credit 

The  methods  of  protecting  bank  notes  and  deposits  have  been 
treated  at  length  in  preceding  chapters.  Bank  acceptances  are  a 
third  form  of  bank  credit  requiring  protection.  This  form  of 
liability  is  incurred  when  a  time  bill  is  presented  and  accepted  by 
the  drawee  bank,  that  is,  the  bank  agrees  to  pay  the  bill  according 


RESERVES  FOR  PROTECTING  BANK  CREDIT  1 55 

to  its  tenor.  The  bill  is  then  known  as  an  "acceptance"  and  is 
practically  a  promissory  note  of  the  bank. 

If  a  bank  owes  some  person,  say,  Henry,  money,  or  has  agreed 
for  a  commission  to  honor  time  drafts  drawn  by  Henry,  Henry 
may  draw  a  bill  on  the  bank  ordering  it  to  pay  to  a  third  party  a 
certain  number  of  days  after  sight  or  date,  and  such  a  bill  may  be 
discounted  in  the  market  either  before  or  after  acceptance  by  the 
drawee  bank.  The  purchaser  of  the  bill  may  insist  that  Henry 
show  him  a  letter  from  the  bank  authorizing  Henry  to  draw  to 
a  certain  amount  and  under  certain  conditions;  such  a  letter  is 
called  a  "letter  of  credit."  To  protect  himself  further  the  pur- 
chaser may  require  Henry  to  attach  commercial  documents  or 
securities  as  collateral  to  the  bill.  Such  documents  as  the  bill 
of  lading,  warehouse  receipt,  and  the  like,  constitute  the  holder 
the  virtual  owner  of  the  goods  represented.  If  the  drawee  fails 
to  accept  the  bill  when  presented  or  to  pay  the  acceptance  when 
due,  the  holder  of  the  bill  and  documents  can  recover  by  liqui- 
dating the  collateral.  A  bill  with  documents  attached  is  known 
as  a  "documentary"  bill,  and  one  without  documents  as  a 
"clean"  bill. 

The  bank  incurs  successively  two  liabilities  in  the  above 
transactions.  In  the  first  place  it  issues  to  Henry  a  letter  of  credit 
agreeing  to  accept  certain  bills  to  a  certain  amount  when  properly 
drawn.  To  protect  itself  against  this  liability  it  may  require 
Henry  to  pledge  collateral  security,  or  to  pay  or  deposit  cash  to 
the  full  amount,  or  to  secure  the  guaranty  of  some  bank  or  finan- 
cial institution  that  he  will  pay  to  the  bank  the  amount  of  the 
bills  drawn  under  the  letter  of  credit  before  they  mature.  The 
transaction  is  reflected  in  the  balance  sheet  by  an  increase  in  the 
liability,  Letters  of  Credit,  and  an  increase  in  the  asset,  Cus- 
tomers' Liability  under  Letters  of  Credit.  The  second  liability 
is  an  absolute  liability  incurred  when  the  bank  accepts  bills  drawn 
under  the  credit.  On  the  liability  side  the  item,  Letters  of  Credit, 
is  decreased  and  the  item,  Acceptances,  increased,  while  on  the 


156  MONEY,  CREDIT,  AND  BANKING 

asset  side  Customers'  Liability  under  Letters  of  Credit  is  de- 
creased and  Customers'  Liability  for  Acceptances  Executed  in- 
creased. If  the  bill  is  documentary,  in  order  to  protect  itself, 
the  drawee  bank  may  at  the  time  of  acceptance  remove  and  keep 
the  documents  and,  if  Henry  does  not  cover  the  bills  drawn 
according  to  the  terms  of  the  letter  of  credit,  may  take  possession 
of  the  goods  and  convert  them  into  cash;  but  if  the  documents  are 
delivered  to  the  person  in  behalf  of  whom  the  bill  was  accepted, 
the  bank  takes  special  precautions  at  the  time  of  acceptance  to 
guard  well  its  interests.  The  safest  way  is  to  deliver  documents 
only  against  payment,  but  commerce  would  be  unnecessarily 
restrained  by  a  rigid  adherence  to  this  plan.  If  the  bill  is  clean 
rather  than  documentary  it  becomes  upon  acceptance  practically 
an  unsecured  promissory  note  and  is  not  necessarily  based  on  a 
commercial  transaction. 

Limitation  of  Acceptance  Credit 

In  addition  to  the  interests  of  the  drawer,  drawee,  acceptor, 
purchaser,  and  the  party  to  whom  the  letter  of  credit  is  issued  and 
his  guarantor,  the  general  public  has  an  interest  in  the  actual  and 
contingent  liabilities  undertaken  by  the  banks.  These  obliga- 
tions, if  recklessly  assumed,  may  seriously  affect  the  banking 
situation.  In  old  banks  experienced  in  the  acceptance  business, 
and  in  banking  communities  which  exercise  a  mutual  guardian- 
ship and  restrain  excessive  accepting  by  any  bank,  the  danger  is 
small;  but  when  experience  in  this  field  of  banking  is  lacking  and 
where  banking  policy  is  conservative  and  sound  in  other  respects 
primarily  because  of  a  severe  system  of  bank  supervision,  the 
state  may  find  it  necessary  to  put  restraints  on  the  free  exercise 
of  the  acceptance  power.  By  limiting  a  bank's  power  to  accept 
only  such  bills  as  arise  out  of  the  importation  and  exportation  of 
merchandise  or  other  such  commercial  transactions,  a  very 
definite  limit  is  put  to  the  extension  of  this  sort  of  credit.  Also 
if  the  total  amount  of  acceptances  outstanding  at  any  one 


RESERVES  FOR  PROTECTING  BANK  CREDIT  157 

time  is  limited  to  some  percentage  of  the  capital  and  surplus  of 
the  bank,  the  liability  can  be  kept  within  safe  bounds.  A  third 
method  is  to  limit  the  aggregate  amount  of  acceptances  bearing 
one  drawer's  name,  thus  distributing  the  risk.  The  United  States 
government  restricts  the  acceptance  powers  of  national  banks  in 
these  ways. 

Difference  Between  Accepting  and  Lending 

A  common  misconception  exists  as  to  the  difference  between 
the  processes  of  accepting  and  lending.  The  misconception,  as 
commonly  stated,  is  that  in  accepting,  the  bank  does  not  part 
with  money  as  it  does  in  lending.  In  preceding  chapters  an  effort 
has  been  made  to  show  that  when  a  bank  lends  it  hardly  ever 
does  more  than  extend  its  demand  liabilities  in  the  form  of  bank 
notes  and  deposits.  If  it  lends  bank  notes,  it  lends  money;  but  the 
proportion  of  bank  notes  to  deposits  is  small  and  the  number  of 
banks  that  issue  notes  is  also  small.  To  say  that  a  bank  lends 
money  when  it  extends  deposits  is  not  exactly  true;  what  is  done 
is  to  extend  its  credit  in  the  form  of  rights  to  draw  money;  to 
only  a  small  degree,  however,  is  money  actually  withdrawn,  for 
in  the  first  place  many  checks  on  the  bank  are  redeposited  with  it, 
and  in  the  second  .place  the  balancing  of  checks  at  the  clearing 
house  leaves  only  small  settlements  to  be  made  and  even  these 
are  not  usually  made  in  money. 

Now  when  a  bank  accepts  a  time  draft  or  bill  of  exchange  it 
lends  its  credit  to  the  drawer.  Instead  of  the  drawer  exchanging 
his  6o-day  promissory  note  for  the  bank's  demand  deposit  credit, 
which  will  more  readily  circulate  in  the  community,  he  draws  a 
6o-day  bill  on  the  bank,  which  by  accepting  the  instrument  ex- 
tends to  the  drawer  the  use  of  its  time  credit  for  60  days.  The 
drawer  then  converts  this  time  credit  into  demand  credit  by  sell- 
ing the  bill  in  the  discount  market  for  bank  notes  or  a  check  or  for 
cash  which  he  immediately  deposits  in  his  bank. 

In  the  foregoing  explanation  the  important  point  to  grasp 


158  MONEY,  CREDIT,  AND  BANKING 

is  that  the  difference  between  accepting  and  lending  is  not  the 
paying  as  against  the  non-paying  of  money,  but  is  the  extension  of 
time  credit  as  against  demand  credit.  In  either  case  the  bank 
incurs  a  direct  liability,  against  payment  of  which  provision 
must  be  made.  The  two  facts:  first,  that  it  is  a  time  liability, 
and  second,  that  the  drawer  has  contracted  to  put  the  bank  with 
funds  before  the  maturity  of  acceptance,  relieve  the  bank  from 
anxiety  about  meeting  the  acceptance.  The  bank  does  not  ex- 
pect to  be  obliged  to  pay  from  its  own  funds;  it  regards  the  lia- 
bility rather  as  a  contingent  one  and  therefore  does  not  concern 
itself  so  much  about  its  reserve.  In  this  there  lurks  a  positive 
danger.  If  due  caution  is  taken  in  selecting  drawers,  in  protect- 
ing the  issue  of  letters  of  credit,  and  in  watching  the  documentary 
securities,  the  need  of  a  reserve  is  small.  No  banker,  however, 
can  trust  in  the  naive  idea  that,  since  accepting  does  not  require 
the  immediate  payment  of  money,  he  may  extend  his  acceptance 
business  to  any  amount  and  keep  no  reserve  as  a  protection  there- 
to. A  reserve  should  be  kept,  but  it  may  be  much  smaller  than 
against  bank  notes  and  deposits. 

Protection  of  Bills  Payable 

A  fourth  form  of  bank  credit  liability  that  requires  protection 
is  Bills  Payable.  When  a  bank  needs  funds  and  does  not  find  it 
expedient  or  possible  to  discount  paper  in  its  portfolio,  it  may 
borrow  from  other  banks  or  financial  institutions  on  its  promis- 
sory note.  Where  the  practice  of  rediscounting,  either  with  the 
central  bank  or  on  the  open  market,  is  the  prevailing  banking 
practice,  borrowing  by  a  bank  on  its  note  is  unusual.  In  contrast 
with  European  practice,  where  a  broad  discount  market  has  been 
developed,  the  practice  of  the  American  banking  system  has  been 
quite  provincial.  The  common  method  in  the  United  States  has 
been  for  a  bank  to  borrow  either  on  its  own  unsecured  note  or  its 
note  secured  by  pledge  of  commercial  paper  or — sometimes — 
securities.    By  this  method  the  paper  need  not  be  indorsed,  and 


RESERVES  FOR  PROTECTING  BANK  CREDIT  159 

the  creditor  protects  himself  by  insisting  upon  a  liberal  margin 
of  safety.  Loans  of  this  kind  are  usually  seasonal  or  arise  in  tight 
money  periods.  A  bank  which  borrows,  in  this  way  generally 
carries  a  good  balance  with  the  creditor  bank  during  the  rest  of 
the  year,  and  thus  establishes  friendly  relations  and  a  potential 
"line  of  accommodation."  Interbank  borrowings  of  this  sort 
tend  to  the  maximum  utilization  of  the  country's  funds  and  the 
equalization  of  money  rates  both  in  place  and  time.  The  loans 
are  more  often  time  loans  than  call  loans. 

During  the  war  the  sudden  demands  upon  the  banks  occa- 
sioned by  large  payments  of  taxes  or  subscriptions  to  loans  made 
it  necessary  to  provide  an  easy  method  of  negotiating  interbank 
loans.  The  federal  reserve  banks  were  authorized  to  loan  to 
member  banks  on  their  bills  payable  secured  by  government 
securities.  This  practice  became  very  common  and  quite  largely 
supplanted  the  rediscount  method. 

The  state  has  less  occasion  to  supervise  and  regulate  opera- 
tions in  bills  payable  than  in  any  other  form  of  bank  credit,  the 
reasons  being  that  such  bills  are  relatively  small,  are  occasional, 
and  are  between  banking  institutions,  which  may  be  presumed  to 
guard  themselves  well.  By  indirection  such  borrowing  may  be 
curtailed,  for,  as  in  the  case  of  other  loans,  the  state  may  limit  the 
liability  to  any  one  creditor  bank  to  a  percentage  of  the  total 
assets  of  that  bank.  A  particular  instance  where  regulation  is 
necessary  to  prevent  the  pyramiding  of  fictitious  credits  arises 
when  a  bank  borrows  from  subsidiaries  or  branches,  or  vice  versa. 

There  are  at  least  three  variations  of  this  method  of  incurring 
liabilities  on  the  bank's  promissory  note,  which  are  as  follows: 

i .  The  borrowing  bank  may  issue  to  the  creditor  bank  a  de- 
mand or  time  certificate  of  deposit,  in  which  case  the  Deposits 
liability  is  increased  rather  than  the  Bills  Payable,  although 
the  difference  between  the  two  is  then  nominal. 

2.  The  borrowing  bank  may  overdraw  its  account  with  its 
correspondent,  which,  if  it  honors  the  draft,  becomes  a  creditor 


160  MONEY,  CREDIT,  AND  BANKING 

by  the  amount  of  the  overdrawal;  the  overdraft  may  be  secured 
by  pledged  collateral  or  may  be  unsecured,  and  is  primarily  a  loan. 

3.  The  borrowing  bank  may  get  its  check  certified  for  an 
amount  in  excess  of  its  balance;  while  the  overcertified  check  is 
in  circulation  the  certifying  bank  is  a  creditor  of  the  borrowing 
bank. 

The  state  usually  regards  these  three  forms  of  borrowing  in 
the  light  of  loans  and  so  classifies  them.  Overdrawing,  and  par- 
ticularly overcertifying,  are  practices  that  are  often  prohibited 
because  they  represent  loose  business  methods  with  their  attend- 
ant danger. 


CHAPTER  X 
RELATION  OF  BANK  CREDIT  TO  PRICES 

Marginal  Utility  and  Price 

Trade  is  fundamentally  barter;  the  money  economy  and  the 
credit  economy  sprang  from  the  barter  economy.  Under  the 
money  economy  one  commodity  possessing  the  quality  of  general 
acceptability  was  exchanged  for  any  other  commodity.  The 
barter  nature  of  such  transactions  is  obvious.  Credit  simply 
introduced  the  idea  of  exchanging  present  commodities  against 
future  commodities;  if  credits  are  offset  by  credits,  the  ultimate 
payment  of  balances  is  in  kind  or  money.  The  person  who  sells 
shoes  for  money  or  credit  gets,  in  real  fact,  commodities  which  the 
money  or  credit  commands.  Exchanges  are,  then,  goods  for 
goods;  and  the  amount  of  one  kind  of  goods  given  for  a  unit  of 
another  is  the  price  of  the  latter.  Since  goods  are  generally  ex- 
changed for  gold  or  representatives  of  gold,  prices  are  usually 
stated  in  terms  of  gold,  and  price  becomes  the  quantity  of  gold 
for  which  a  unit  of  an  article  will  exchange. 

Commodities  serve  in  different  degrees  the  wants  of  man. 
The  capacity  to  satisfy  a  want  is  known  in  political  economy 
as  "utility."  The  utility  of  any  unit  of  a  commodity  decreases 
as  the  number  of  units  of  that  commodity  increases.  The 
utility  of  a  unit  more  or  less  than  any  given  group  is  spoken 
of  as  "marginal"  utility.  The  asking  price  of  any  commodity 
will  depend  upon  the  ratio  of  the  marginal  utility  of  the  com- 
modity and  the  marginal  utility  of  gold,  that  is,  money,  to  the 
seller;  the  bidding  price  is  likewise  the  ratio  of  these  utilities 
to  the  buyer.  When  a  sale  or  purchase  takes  place  there  is  an 
equalization  of  these  ratios  of  utilities,  at  a  "price."  In  any 
market  where  buyers  and  sellers  compete  freely  there  can  be  but 

VOL.    I — II  l6l 


1 62  MONEY,  CREDIT,  AND  BANKING 

one  price  for  a  commodity  at  any  time;  this  resultant  price  is  the 
"market  price." 

Basis  of  Price  Level 

It  is  apparent  that  the  market  price  of  any  commodity  will  be 
high  if  that  commodity  has  high  utility  or  if  the  commodity  is 
relatively  scarce,  or,  on  the  other  hand,  if  money  is  plentiful  and 
therefore  has  low  marginal  utility.  The  price  of  any  commodity 
depends,  therefore,  upon  its  relative  utility  as  compared  with 
other  commodities  and  upon  the  price  of  other  commodities  in 
general,  that  is,  the  price  level;  but  the  price  level  is  an  average 
ratio  between  the  quantities  of  goods  exchanged  and  the  quantity 
of  money  against  which  they  are  exchanged.  The  quantity  of 
money  has  two  elements :  the  number  of  units  of  money,  and  the 
number  of  times  that  these  units  are  exchanged  against  goods 
within  a  period.  Ignoring  for  the  time  being  the  influence  of  de- 
posit currency,  the  price  level  depends  upon  three  factors:  (i) 
the  quantity  or  number  of  money  units  in  circulation,  (2)  their 
velocity  of  circulation,  and  (3)  the  quantity  of  goods  against 
which  they  are  exchanged.  The  price  level  varies  directly  as  the 
quantity  of  money  and  the  velocity  of  circulation  and  inversely  as 
the  volume  of  goods  traded.  This  is  the  quantity  theory  of 
money.  The  price  level  varies  with  the  total  purchasing  power  of 
the  community,  and  this  purchasing  power  is  the  product  ob- 
tained by  multiplying  the  number  of  dollars  in  circulation  by  the 
number  of  times  the  dollars  circulate  within  a  period.  Or  stated 
inversely,  the  value  of  a  dollar  (its  power  tq  command  articles  in 
exchange)  decreases  as  the  number  of  dollars  or  their  rate  of  cir- 
culation increases. 

Effect  of  Money  and  Deposits  on  Price  Level 

The  purchasing  capacity  of  an  individual  at  any  time  (his 
power  to  command  goods  in  the  market)  is  increased  by  his  bank 
deposits  subject  to  transfer  by  check — instead  of  paying  by 


RELATION  OF  BANK  CREDIT  TO  PRICES  1 63 

money  he  pays  by  check.  The  statement  of  the  quantity  theory 
must,  therefore,  include  the  volume  of  bank  deposits  and  the 
rate  at  which  they  circulate.  The  best  statement  of  the  theory  is 
probably  contained  in  Professor  Irving  Fisher's  formula,  M V 
plus  M'V  —P  T,  in  which  M  is  the  quantity  of  money  in  circu- 
lation, V  the  rate  of  turnover  of  money,  M '  the  quantity  of  de- 
posits subject  to  check,  V'  the  rate  of  turnover  of  deposits,  P  the 
price  level,  and  T  the  volume  of  trade. 

But  M  and  M '  are  not  independent  factors;  they  bear  a  more 
or  less  constant  ratio  to  each  other,  because  of  two  facts:  (1)  that 
bank  reserves  are  kept  in  a  more  or  less  definite  ratio  to  bank  de- 
posits, out  of  the  requirements  of  law  or  business  expediency;  (2) 
that  individuals,  firms,  and  corporations  preserve  more  or  less  def- 
inite ratios  between  their  cash  transactions  and  their  check  trans- 
actions, and  also  between  their  money  on  hand  and  deposit  bal- 
ances. In  a  given  community  the  quantitative  relation  of  deposit 
currency  to  money  in  circulation  is  determined  by  considerations 
of  convenience;  and  while  the  ratio  differs  greatly  for  the  individ- 
ual, for  the  community  the  average  ratio  is  quite  constant  and 
can  be  approximately  determined.  If  the  ratio  of  bank  reserves 
to  M'  is  1 :  4,  this  means  that  as  the  quantity  of  bank  reserves  in- 
creases, M'  may  expand  four  times  the  amount  of  the  reserve 
increase.  For  instance,  if  the  quantity  of  money  in  bank  re- 
serves were  $1,000,000  and  the  superposed  M',  $4,000,000,  an 
increase  of  the  reserves  to  $2,000,000  would  bring  M'  to  $8,000,- 
000.  The  price  level  P  will  vary  with  the  combined  amounts  of 
M  and  M'.  A  lowering  of  reserve  requirements  is,  therefore, 
likely  to  bring  a  higher  price  level  through  the  inflation  of  deposits. 

« 
Remoter  Influences  on  Prices 

The  five  factors,  M,  M',  V,  V,  and  T,  are  the  only  factors 
that  can  affect  P  directly.  Any  other  influences  on  prices  must 
act  through  one  or  more  of  these  five  factors  and  there  are  hun- 
dreds of  such  influences.    M  is  affected  by  such  factors  as  the 


164  MONEY,  CREDIT,  AND  BANKING 

production  of  gold  and  other  metals,  their  consumption  in  the 
arts,  the  habit  of  hoarding,  the  international  shipment  of  specie, 
and  so  forth.  V  and  V  depend  upon  the  methods  of  making 
payment — how  frequent,  how  regular,  how  synchronized  with 
receipts — the  habit  of  hoarding,  the  facilities  of  communication, 
the  development  of  banking,  and  the  like.  M'  varies  with  the 
banking  system,  with  the  extent  of  the  use  of  deposit  currency  and 
with  industrial  conditions.  T  is  affected  by  geographical  differ- 
ences in  natural  resources,  the  division  of  labor,  the  knowledge  of 
the  technique  of  production,  the  accumulation  of  capital,  the 
extent  and  variety  of  human  wants,  facilities  of  transportation, 
freedom  of  trade,  the  character  of  the  monetary  and  banking 
systems. 

To  illustrate:  Consider  the  effect  of  the  introduction  and 
development  of  the  telegraph  on  the  price  level.  This  means  of 
communication  has  increased  the  velocity  of  the  circulation  of 
money  (V)  and  of  deposits  (V)  and  therefore  has  tended  to  in- 
crease prices  (P) ;  it  has  also  facilitated  production  and  increased 
the  volume  of  trade  (P),  and  therefore  has  tended  to  lower  prices. 
The  net  resultant  of  these  two  opposing  forces  is  difficult  to  deter- 
mine, but  it  was  probably  upward.  Or  consider  the  effect  of  the 
immigration  of  foreign  workmen  to  our  country.  It  has  increased 
the  total  production  and  trade  (P),  and  therefore  tended  to  lower 
prices  (P);  it  has  also  occasioned  a  continuous  outgo  of  funds 
from  our  country  to  friends  in  the  emigrant  country,  reducing 
M  and  M',  and  therefore  P.  The  immigrants  have  tended  largely 
to  live  in  cities  and  other  densely  populated  areas,  and  thus  to 
accelerate  the  velocity  of  money  (V)  and  of  deposits  (V)  and  to 
foster  banking  accounts  (Af),  and  therefore  to  increase  prices 
(P).  In  this  instance  also  the  net  effect  of  these  influences  on  the 
various  factors  is  difficult  to  determine.  These  illustrations  are 
sufficient  to  suggest  to  the  reader  that  too  categorical  statements 
as  to  the  effect  of  some  factor  on  the  price  level  are  dangerous 
unless  careful  consideration  is  given  to  the  various  and  often  con- 


RELATION  OP  BANK  CREDIT  TO  PRICES  165 

flicting  ways  in  which  a  particular  factor  may  possibly  affect  the 
price  level. 

Index  Numbers 

The  price  level  is  calculated  and  estimated  in  terms  of  an 
index  number,  which  is  some  form  of  average  of  prices  of  repre- 
sentative commodities.  When  the  price  level  rises  or  falls  the 
prices  of  all  commodities  do  not  rise  or  fall  together  or  in  the  same 
degree  or  direction.  The  index  number  is  simply  an  average  of 
prices,  or  of  the  percentages  of  increase  or  decrease  of  prices, 
of  a  selected  list  of  commodities. 

In  the  preparation  of  index  numbers  there  are  many  considera- 
tions which  vitally  affect  their  usefulness,  among  which  are  the 
following : 

1 .  The  Prices  Used.  What  prices  should  be  used  is  governed 
by  the  purposes  to  which  the  index  number  is  devoted.  If  the 
index  is  to  be  used  over  a  broad  area,  the  prices  should  be  those 
prevailing  in  a  central,  organized,  competitive  market.  If  the 
price  movement  in  a  limited  locality  is  to  be  studied  only  prices 
obtaining  in  that  locality  should  be  used. 

Wholesale  prices  fluctuate  more  widely  and  are  more  quickly 
responsive  to  changes  in  supply  and  demand  than  retail  prices. 
An  index  number  based  upon  wholesale  prices  is  therefore  a  better 
barometer  of  business  conditions  for  manufacturers,  jobbers, 
large  credit-grantors,  and  the  like,  but  an  index  number  based 
upon  retail  prices  measures  better  the  changes  in  the  cost  of  living 
and  the  proper  adjustment  of  wages  thereto.  In  any  case,  the 
average  price  for  the  day,  week,  or  month  is  better  for  purposes  of 
comparison  than  the  prices  on  the  market  at  a  certain  instant. 

2.  The  Commodities  Used.  As  it  is  impossible  to  include  all 
commodities  in  the  preparation  of  an  index  number,  only  the 
principal  ones  are  used ;  but  the  more  the  better,  for  the  index  is 
then  the  more  representative.  If,  for  example,  the  index  is  to  be 
used  to  determine  the  variations  in  the  cost  of  living  for  a  particu- 


1 66  MONEY,  CREDIT,  AND  BANKING 

lar  class  of  workmen,  the  commodities  used  should  be  those  that 
compose  his  budget.  A  wider  use  requires  a  larger  and  more 
general  list  of  goods. 

3.  The  Base  Prices  Used.  Care  is  necessary  lest  the  base  year 
be  a  year  of  exceptionally  high  or  low  prices,  and  the  percentage 
of  increase  or  decrease  be  thereby  vitiated.  To  overcome  this 
danger,  it  is  best  to  use  as  the  base  the  average  prices  for  a  decade ; 
the  Sauerbeck  index  number,  for  instance,  uses  the  average  prices 
for  the  decade  1858-1867. 

4.  The  Kind  of  Average  Used.  Of  the  common  methods  of 
averaging  a  series  of  numbers  the  following  four  may  be  noted: 

(a)  One  method  is  to  arrange  the  numbers  in  a  series  accord- 
ing to  their  magnitude  and  choose  the  middle  figure,  which  is 
called  the  "median."  It  is  the  easiest  of  all  methods  to  calculate 
and  does  not  attach  undue  importance  to  very  high  and  very  low 
numbers;  on  the  other  hand,  it  pairs  numbers  regardless  of  the 
relative  quantities  sold  at  the  respective  prices. 

(b)  A  second  method,  the  "geometrical"  average,  is  to  take 
the  nth  root  of  the  product  of  the  n  prices  or  of  the  prices  of  n 
commodities,  n  signifying  any  given  number.  The  chief  criticism 
of  this  is  the  difficulty  of  its  calculation,  as  it  requires  the  use  of 
logarithms. 

(c)  A  still  more  awkward  average  to  calculate  is  the  "simple 
harmonical"  average,  which  is  the  reciprocal  of  the  sum  of  the 
reciprocals  of  the  prices. 

(d)  By  far  the  most  common  average  is  the  "simple  arith- 
metical" average  which  is  the  quotient  of  the  sum  of  n  prices 
divided  by  n.  To  make  the  average  more  exact  the  prices  are 
"weighted"  by  using  as  the  multiplier  numbers  which  indicate 
the  relative  quantities  of  the  commodities  sold  at  the  respective 
prices,  and  the  sum  of  these  products  is  then  divided  by  the  sum 
of  the  weights.  This  "weighted  arithmetical  average"  is  quite 
generally  used  and  it  has  the  advantage  of  being  fairly  easy  to 
calculate. 


RELATION  OF  BANK  CREDIT  TO  PRICES 


167 


Another  common  form  of  index  number  is  to  state  the  sum 
of  values  of  the  same  quantities  of  goods  at  their  respective 
prices  prevailing  at  different  dates. 

Whatever  form  of  average  is  used,  the  results  are  approxi- 
mately the  same;  exactitude  is  not  expected,  for  the  numbers  are 
but  indexes  of  price  changes. 

Useful  index  numbers  are  those  of  the  London  Economist, 
Sauerbeck,  Dun,  Bradstreet,  Gibson,  the  United  States  Bureau 
of  Labor  Statistics,  the  Canadian  Department  of  Labor,  and  the 
Annalist.  The  following  table  gives  some  of  these  numbers  for 
recent  years: 

Index  Numbers 


English 

American 

Date 

London 
Economist 

Sauerbeck 
Statist 

Board  of 
Trade 

Canadian 

Department 

of  Labor 

U.  S.  Bureau 
of  Labor 
Statistics 

Gibson 

Bradstreet 

1950 
1890 
1918 
3145 
2126 
1948 
2003 
3197 
3136 
3342 
2499 
2310 
2197 
2373 
2513 
3586 
3580 
3692 
2658 
3329 
4316 
5418 
6036 
6336 

61 

62 

64 

68 

75 

70 

69 

69 

70 

72 

77 

80 

73 

74 

70 

80 

85 

85 

85 

108 

136 

175 

198 

206 

92  5 
92.2 
96.1 

1 00. 1 
108.2 
107.0 
109.0 
110.5 
in. 4 
113. 8 
120.0 
126.2 
120.8 

121. 2 
124.2 
127-4 
134-4 
135-5 
136. 1 
148.0 
183.O 
3370 
379-7 
393-9 

90.4 
89.7 
93-4 
101  7 
hi  5 
108.5 
112. 9 
113-6 
1130 
iiS-9 
122.5 
1295 
122.8 
126.5 
131.6 
129.2 
133.6 
135.2 
133.8 
135-2 
166.3 
236.6 
266.3 
386.6 

34-0 
34-7 
38  7 
41.6 
44.2 
44-5 
53-5 
490 
48.3 
47-2 
49-8 
50.9 
54-3 
592 
59-3 
56.O 
62.6 
58.1 
60.8 
64.0 
74-9 
no. 8 

133.8 

121.4 

59124 

1898 

6.5713 

1900 
1901 
1902 
1903 
1904 
1905 
1906 
1907 
1908 
1909 
1910 
1911 
1912 
1913 
1914 
1915 
1916 
1917 
1918 
1919 

100. 0 
96.7 
96.4 
96.9 
98.2 
97-6 

100.8 
106.0 
1030 

104. 1 
108.8 
109-4 
1 14.9 
116.5 
117. 3 
143-9 
186.5 
343-0 
267.4 
296.3 

7.8839 
7.5746 
7-8759 
79364 
7.9187 
8.0987 
8.4176 
8.9045 
8.0094 
8.5153 
8.9881 
8.7129 
9.1867 
92115 
8.9985 
9.8531 
11.8236 
15.6385 
18.7117 
18.6642 

168  MONEY,  CREDIT,  AND  BANKING 

Inflation  and  Its  Effects 

According  to  the  quantity  theory  of  money,  most  exactly 
stated  in  Professor  Fisher's  "  equation  of  exchange,"  an  increase  in 
money  and  bank  credit  beyond  the  needs  of  trade  at  a  given  price 
level  tends  to  raise  that  price  level.  Such  is  the  common  concep- 
tion of  inflation.  The  equal  and  simultaneous  movements  of 
total  purchasing  power  and  trade  would  result  in  a  stable  price 
level.  Total  purchasing  power  has  been  shown  to  be  the  sum  of 
two  products,  namely,  the  quantity  of  money  in  circulation 
multiplied  by  its  efficiency  (or  velocity  of  circulation)  and  the 
quantity  of  bank  deposits  multiplied  by  their  efficiency.  If 
this  total  purchasing  power  remains  the  same  but  the  quantity 
of  trade  declines,  there  will  be  inflation.  If  the  quantity  of  trade 
remains  the  same,  then  inflation  may  be  caused  by  increases  in 
the  quantity  of  money  or  of  bank  credit,  or  in  their  efficiencies. 
There  can  be  gold  inflation  as  well  as  paper  money  inflation  or 
bank  credit  inflation. 

It  is  quite  impossible  to  determine  the  actual  volume  of  goods 
that  enter  into  trade  during  a  certain  period  in  a  complex  coun- 
try like  ours.  The  relative  increase  or  decrease  may,  however, 
be  approximated  from  certain  indexes.  The  best  barometers  of 
trade,  measured  in  physical  units  and  not  in  dollars  of  value,  are 
the  production  of  the  basic  materials,  such  as  coal,  iron,  petroleum, 
copper,  silver,  the  production  of  agricultural  commodities,  the 
tonnage  of  the  railroads,  the  tonnage  of  vessels  entered  and 
cleared  at  lake  ports  and  seaports,  the  number  of  building  permits, 
and  the  number  of  shares  traded  on  the  stock  exchanges. 

The  volume  of  money  in  circulation  and  that  of  bank  deposit 
currency,  as  well  as  the  velocity  of  both  of  these,  can  be  statistically 
determined  with  a  fair  degree  of  exactne  s.  Professor  Irving 
Fisher  publishes  annually  the  data  for  his  "equation  of  ex- 
change." Professor  Kemmerer  recently  published1  the  following 
indexes  bearing  upon  war  inflation : 

1  American  Economic  Review,  June  1918. 


RELATION  OF  BANK  CREDIT  TO  PRICES 

Indexes  Bearing  on  War  Inflation 


169 


Year 

Trade 

Wholesale 
Prices 

Union 
Wage 
Rates 

Money 

in 
Circu- 
la- 
tion 

Gold 
&Gold 
Cer- 
tifi- 
cates 

Bank 
Depos- 
its 

Total 
Bank 
Clear- 
ings 

Clearings 
Outside 
of  New 

York  City 

Cash 
Reserve 

of 
Banks 

Reserve 
Percent- 
age 

1910 
1911 
1912 
1913 
1914 
191s 
1916 
1917 

93 
95 
102 
105 
104 
108 
113 
127 

99 
97 

IOI 

102 

IOI 
102 
125 

178 

96 
98 
100 
102 
105 
106 
109 
117 

95 
98 
100 
102 
106 
III 
125 
148 

92 
98 

IOI 

105 
105 
119 
150 
185 

90 
94 
102 
104 
no 

118 

147 
174 

100 
97 
106 
103 
94 
114 
159 
186 

94 
96 
103 
106 
102 
109 
144 
182 

93 
98 
101 
101 
106 
116 
130 
153 

12.5 
12.6 
12.0 
n. 7 
II. 7 
II.9 
10.7 
10.6 

Undoubtedly  the  velocity  of  the  circulation  of  money  and 
that  of  deposits  also  increased  during  this  period.  Combining 
the  factors  of  purchasing  power,  it  is  very  evident  that  they  in- 
creased faster  than  trade  and  explain  the  decided  inflation  of 
prices. 

Inequalities  of  Inflation 

Increases  of  money  and  bank  credit,  if  used,  tend  to  price 
inflation,  but  they  do  not  inflate  all  prices  equally  because  there  is 
not  an  equal  demand  for  all  kinds  of  things  or  services.  The  infla- 
tion comes  not  simply  from  an  increase  in  the  quantity  of  pur- 
chasing power,  but  from  the  increasing  competitive  efforts  to 
exchange  the  money  or  credit  for  things  and  services;  if  no  at- 
tempt were  made  to  use  the  enlarged  purchasing  facilities  there 
would  be  no  effect  upon  prices. 

An  abnormal  demand  for  munitions,  for  instance,  and  the  use 
of  almost  unlimited  supplies  of  money  and  credit  in  competitive 
bidding  during  the  years  1914-1919,  caused  a  great  increase  in 
their  price.  But  the  price  of  real  estate  did  not  rise  because  little, 
if  any,  of  the  new  credit  was  used  for  purchasing  real  estate.  The 
high  profit  in  the  manufacture  of  munitions  tended  to  cause  the 
transfer  of  capital  from  the  development  of  real  estate  to  the 


170  MONEY,  CREDIT,  AND  BANKING 

manufacture  of  munitions.  This  drift  of  capital  was  accompanied 
by  a  drift  of  laborers  eager  to  earn  the  higher  wages  paid  in 
munition  factories.  Employers  in  other  lines  of  business  then 
found  that  they  had  to  give  their  employees  higher  wages  to  hold 
them;  they  had  to  bid  for  capital  in  like  manner.  The  demand  for 
many  products  was  increased  by  the  higher  purchasing  power  of 
the  munition  workers  and  manufacturers.  In  consequence  there 
followed  an  equalization  of  wages  and  prices  in  the  various  lines; 
that  is,  the  inflation  became  quite  general. 

It  has  been  previously  stated  that  in  1914-1918  real  estate 
prices  did  not  rise  with  the  inflation  because  capital  funds  were 
devoted  largely  to  other  uses.  Nor  did  wages  and  salaries  respond 
with  such  uniform  rapidity  as  the  price  level  of  goods.  This  un- 
responsiveness was  due  to  the  same  fact,  viz.,  that,  relatively 
speaking,  less  was  spent  upon  these  items  than  upon  goods.  The 
wage-earner  lacks  the  ability  to  foresee  the  depreciation  in  the 
purchasing  power  of  his  earnings  as  the  prices  of  his  budget  rise; 
and  even  when  he  does  foresee  it,  his  timidity  often  prevents  him 
from  wresting  a  just  advance  from  his  employer.  The  simulta- 
neous advances  of  wages  and  prices  is  prevented  by  lack  of  fore- 
sight, or  by  custom,  or  contract,  or  union  wage  bargain.  Salaries 
respond  still  more  slowly.  In  times  of  rising  prices  the  employer 
of  labor  is  therefore  at  an  advantage  and  the  employee  finds  his 
real  earning  power  declining  pari  passu  with  the  rise. 

Interest  Rate  and  Inflation 

Nor  does  the  interest  rate  rise  in  proportion  to  the  inflation. 
The  loaning  class  is  less  shrewd  and  apt  in  sensing  conditions  and 
is  usually  content  for  a  time  to  loan  at,  say,  3  per  cent  to  bor- 
rowers who  would  be  willing,  if  necessary,  to  pay  5  per  cent.  The 
enterprisers  enjoy,  therefore,  the  further  advantage  of  borrowing 
money  at  the  former  low  rates.  This  encourages  borrowing,  and 
thereby  the  creation  of  more  deposits;  and  these  in  turn  swell 
prices  still  higher  and  make  borrowing  still  more  advantageous. 


RELATION  OF  BANK  CREDIT  TO  PRICES  171 

Periods  of  rising  prices  are  therefore  boom  times  for  the  manu- 
facturer; he  buys  material  at  today's  prices,  and  by  the  time  they 
are  manufactured  he  rinds  their  prices  have  risen  with  the  general 
price  level.  He  hires  labor  at  former  or  slightly  advanced  rates 
and  he  borrows  capital  at  former  or  lethargically  rising  rates. 
The  market  for  his  product  is  steady  and  waiting,  at  good  prices, 
and  profits  are  high, 

Meantime  the  wage-earner  is  victimized  by  a  progressive  de- 
preciation of  his  earning  power.  The  salaried  man  sutlers  like- 
wise, as  does  anyone  whose  money  income  is  a  fixed  sum.  The 
bondholder,  for  example,  finds  that  his  interest  will  buy  less  and 
less  and  that  the  purchasing  power  of  his  principal  when  repaid 
has  decreased.  The  real  value  of  fixed  rentals  likewise  declines. 
The  thrifty  saver  finds  his  life's  accumulations  shrinking  in  worth 
to  him.  The  income  from  endowments  of  educational  and  charit- 
able institutions  decrease  in  purchasing  power,  making  it  impos- 
sible to  continue  the  former  scale  of  operations.  On  the  other 
hand,  the  debtor  class  are  enabled  to  extricate  themselves  from 
debt  by  the  repayment  of  a  sum  much  less  in  its  purchasing 
power  than  the  sum  borrowed. 

Schemes  of  Price  Adjustment 

Obviously  this  system  is  unjust.  It  encourages  debt  and  dis- 
courages thrift.  It  burdens  the  creditor,  the  wage-earner,  and 
the  salaried  class.  It  lets  the  shrewd  enterpriser  class  batten  on 
the  poor,  the  ignorant,  and  the  thrifty.  The  remedy  for  these 
evils  is  to  stabilize  the  purchasing  power  of  money.  The  lender 
might  theoretically  compensate  himself  by  demanding  additional 
interest ;  if,  for  instance,  he  is  content  with  5  per  cent  interest  but 
prices  are  rising  3  per  cent  per  year,  he  should  ask  8  per  cent  inter- 
est. Wages  and  salaries  might  be  adjusted  in  proportion  to  the 
inflation  of  budgets.  Repayments  of  loans  might  be  on  the  basis 
of  index  numbers;  $1,200,  for  example,  should  be  repaid  if  prices 
have  arisen  20  per  cent  during  the  period  of  a  $1 ,000  loan.    Prom- 


iy2  MONEY,  CREDIT,  AND  BANKING 

issory  notes,  wage  contracts,  and  bonds,  for  instance,  might  be 
drawn  to  provide  for  repayment  proportioned  to  changes  in  the 
price  level.  The  use  of  index  numbers  for  the  purpose  of  making 
such  adjustments  is  an  illustration  of  "multiple  standards,"  that 
is,  a  standard  of  value  based  on  the  mean  price  of  a  number  of 
commodities. 

The  objections  to  multiple  standards  are  of  a  threefold 
nature: 

i.  "The  uncertainty  as  to  the  best  way  of  computing  index 
numbers,  the  varying  results  reached  by  different 
methods  of  equal  validity,  the  difficulty  of  recording 
with  certainty  the  actual  changes  in  prices,  the  inevit- 
able margin  of  error."2 

2.  The  cessation  of  certainty  and  calculability  in  all  credit 

transactions,  thus  adding  to  the  speculative  risk  and 
element  in  business. 

3.  The  question  whether  commodity  or  labor  standards 

are,  after  all,  really  fair  bases  for  computing  postponed 
payments. 

Professor  Irving  Fisher  has  recently  advocated  a  scheme 
known  as  the  "compensated  dollar"  for  stabilizing  its  purchasing 
power.  The  plan  is  to  retain  our  present  system  of  certificates 
and  coins  in  part,  and  make  them  redeemable  at  the  mint  for 
quantities  of  gold  varying  with  the  index  number  calculated  by  a 
government  bureau.  Adjustments  would  be  made  quarterly  or 
monthly  in  the  "bullion  dollar,"  for  which  the  coined  dollar  (or 
certificate)  would  be  exchangeable.  The  pure  gold  in  the  coined 
gold  dollar  is  23.22  grains;  if  the  price  level  were  to  rise  2  per  cent 
during  the  quarter,  the  coined  dollar  (or  certificate)  might  be 
exchanged  at  the  mint  for  102  per  cent  of  23.22  grains  of  uncoined 
gold  at  the  will  of  the  holder;  or,  vice  versa,  the  holder  of  23.6844 


'Taussig,  Principles  of  Economics,  Vol.  I.,  p.  30a. 


RELATION  OF  BANK  CREDIT  TO  PRICES  1 73 

grains  of  bullion  could  exchange  it  at  the  mint  for  $i  in  coin  (or 
certificate). 

The  above  plan  constitutes  a  system  of  adjustable  seigniorage, 
the  seigniorage  increasing  or  decreasing  with  the  rise  or  fall  of  the 
index  number  respectively.  Or,  stated  otherwise,  the  mint  price 
of  gold  would  vary  inversely  with  the  price  level.  Under  these 
conditions  the  coined  dollar  would  purchase  exactly  the  same 
amount  of  commodities,  other  than  gold,  the  year  round.  If  the 
price  level  rose  i  per  cent  the  coined  dollar  would  exchange  for 
i  per  cent  more  gold,  and  this  would  exchange  for  the  former 
amount  of  other  goods.  Instead  of  the  purchasing  power  of  a 
fixed  amount  of  gold  (23.22  grains)  varying,  the  amount  of  gold 
would  increase  or  decrease  so  as  to  have  a  fixed  purchasing  power 
over  other  goods.  The  more  frequent  the  adjustments  of  the 
seigniorage  the  more  stable  would  be  the  price  level.  Too  fre- 
quent melting  and  minting  of  coins  could  be  checked  by  a  small 
brassage  charge;  and  speculation  in  gold  on  the  market  could  be 
defeated  by  limiting  the  adjustment  made  at  any  one  time. 

Inflation  has  certain  advantages.  It  stimulates  industry  by 
increasing  profits  to  enterprisers,  and  this  may  be  desirable  in 
times  of  emergency.  It  also  tends  to  force  economies  in  consump- 
tion and  limits  extravagant  and  luxurious  spending.  The  benefits 
of  inflation,  however,  are  more  than  counterbalanced  by  its  evils. 

Financial  Panics  and  Industrial  Crises 

Earlier  in  the  chapter  it  was  shown  that  a  period  of  rising 
prices  is  a  period  of  business  boom,  inasmuch  as  profits  of  the 
enterpriser  are  then  unusually  large.  Interest  on  the  manufac- 
turer's growing  investment  and  the  wages  and  salaries  of  his 
employees  are  then  stationary,  whereas  the  value  of  his  product 
grows  more  than  normally  during  the  process  of  production,  his 
materials  rising  with  the  general  price  level,  and  marketing  costs 
are  relatively  low,  in  a  sellers'  market.  The  unusual  profits  in- 
duce enterprisers  to  increase  their  producing  capacity,  and  they 


174  MONEY,  CREDIT,  AND  BANKING 

borrow  more  heavily  to  finance  their  enlarged  production  and 
their  plant  extensions.  The  increased  borrowing  brings  about  the 
creation  of  deposit  currency  which  when  used  tends  to  raise  the 
price  level  still  higher,  causing  the  borrowing  of  greater  and 
greater  sums.    A  vicious  circle  is  thus  formed. 

But  these  operations  obviously  cannot  go  on  indefinitely. 
The  cycle  is  stopped  by  the  rising  costs  of  doing  business  and  the 
exhaustion  of  credit.  The  excess  of  demand  over  supply  of  loans 
finally  forces  up  the  rate  of  interest;  labor,  which  has  become 
pinched  by  the  high  cost  of  living,  finds  itself  strategically  well 
situated  for  demanding  higher  compensation.  Meanwhile  the 
extensions  of  bank  credit  have  reduced  the  ratio  of  cash  reserve  to 
deposits  to  the  danger  point,  and  bankers  are  forced  to  refuse  new 
loans  or  even  to  refuse  to  renew  time  loans  and  to  call  demand 
loans.  This  contraction  forces  a  halt  in  business  promotions ;  pro- 
jects come  to  nothing  or  suspend  unfinished.  Finance  houses 
suddenly  find  themselves  surfeited  with  undigested  securities. 
Borrowers  have  to  liquidate  securities  to  raise  funds,  or  lenders 
have  to  sacrifice  collateral  to  cover  unpaid  loans.  Interior  banks 
taking  fright  recall  their  funds  deposited  in  metropolitan  banks, 
and  thus  force  further  liquidation.  The  result  is  a  financial  stress 
and  break — a  precipitate  crash  on  the  stock  market — a  panic. 
Some  disturbances  of  this  type  stop  at  this  point  and  are  known 
as  "money  panics,"  or  " bankers'  panics,"  or  "Wall  Street  pan- 
ics." The  undertone  of  commerce  and  production  may  be  strong, 
and  only  the  surface  phenomena — that  is,  money  and  finance — 
need  be  adjusted.  If  such  be  the  case,  the  recovery  of  normal 
conditions  will  be  speedy  and  the  losses  will  have  been  sustained 
largely  by  the  financing  and  speculating  group  of  business  men. 
Such,  for  instance,  were  the  panics  of  1884  arid  1903. 

Overproduction  and  Underproduction 

But  sometimes  the  commercial  and  industrial  basis  is  also 
decidedly  unsound.   The  cycle  of  prosperity  has  brought  an  over- 


RELATION  OF  BANK  CREDIT  TO  PRICES  175 

extension  in  many  lines,  and  the  necessary  adjustments  must  be 
more  fundamental.  Probably  the  most  incisive  criticism  of  our 
capitalistic  system  is  that  production  is  carried  on  without  proper 
co-ordination  of  different  lines,  so  that  suddenly  society  finds  that 
too  much  of  its  energy  has  been  devoted  to  the  production  of 
certain  things  and  too  little  to  others.  Capitalistic  production 
connotes  production  in  advance  of  need;  it  requires  much  time — 
and  the  different  industries  require  different  lengths  of  time — for 
the  delivery  of  products.  Capitalistic  production  is  based  on 
specialization,  one  group  producing  one  thing  which  it  exchanges 
for  the  things  produced  by  other  groups.  The  quantity  of  any 
one  product  that  can  be  absorbed  by  the  community  is  quite 
definitely  related  to  the  quantities  of  other  goods  produced  for 
exchange.  Unemployment  and  overproduction  are  but  ill  adjust- 
ments of  this  proportion.  The  exchange  ratio  (the  price)  of 
goods  is  the  index  by  which  the  production  of  this  or  that  com- 
modity is  actually  controlled.  Society  under  the  capitalistic 
system  relies  upon  her  enterprisers  to  gauge  and  forecast  these 
prices  and  to  adjust  production  so  as  to  maintain  a  relatively 
steady  and  proportioned  flow  of  goods.  In  a  single  industrial 
plant  the  general  manager  so  apportions  the  labor,  materials, 
and  space  as  to  secure  harmonious  adjustment  of  the  outputs  of 
the  various  divisions.  If  in  assembling  the  final  product  five 
pinions  are  required  for  every  axle,  the  plant  is  organized  to  pro- 
duce them  in  that  proportion.  But  society  lacks  such  a  general 
organizer  and  administrator;  each  producer  is  free  to  produce 
what  he  will,  in  what  amounts  he  thinks  best.  The  result  is 
spasmodic  overproduction  and  underproduction  in  various  lines. 
A  sort  of  anarchy  prevails,  and  production  and  consumption  are 
in  constant  flux  and  readjustment. 

This  lack  of  correlation  between  supply  and  demand  arises, 
therefore,  from  various  causes:  In  the  first  place,  production  is 
made  in  anticipation  of  demand,  and  the  interim  between  produc- 
tion and  consumption  varies  with  the  commodity  and  is  not 


176  MONEY,  CREDIT,  AND  BANKING 

always  determinable.  The  demand  is  also  difficult  to  estimate 
for  it  is  subject  to  varying  influences  and  changes  often  with  the 
caprice  of  fashion,  legislation,  politics,  and  the  like.  The  en- 
terprisers, moreover,  are  not  omniscient.  In  the  second  place, 
even  if  enterprisers  were  able  to  forecast  perfectly  the  demand, 
they  might  not  be  able  immediately  to  readjust  their  production, 
for  there  is  a  certain  immobility  in  the  factors  of  production ;  the 
enterpriser  may  logically  conclude  that  it  is  better  for  him  to  run 
at  a  small  loss  than  to  shut  down  the  whole  plant;  or  he  may  de- 
cide to  flood  the  market  on  purpose  to  drive  his  less  able  competi- 
tors to  the  wall.  Finally,  one  enterpriser  has  no  control  over  his 
competitors;  he  may  gauge  the  demand  perfectly,  but  find  when 
he  has  his  product  ready  for  sale  that  the  market  is  glutted  with 
competing  supplies,  whereas  in  other  lines  of  commodities  there  is 
a  dearth. 

Whatever  the  causes  of  periodic  or  spasmodic  overproduction, 
it  is  a  characteristic  phenomenon  of  the  capitalistic  system  that 
from  time  to  time  certain  products  can  be  sold  only  at  a  loss. 
The  result  is  that  many  commercial  and  industrial  concerns  fail 
and  also  involve  their  creditors  in  ruin. 

Effect  of  Investment  on  Production 

Overproduction  in  a  certain  line  is  often  largely  explained  by 
overinvestment  therein.  If  a  field  of  investment  gives  promise  of 
permanent  high  earnings,  capital,  and  thereby  labor,  are  diverted 
to  it  from  other  industries  which  suffer  in  consequence.  The 
capital  stocks  of  the  flourishing  industries  are  freely  bought,  often 
on  credit,  and  much  speculation  usually  attends  the  price  move- 
ments of  these  shares.  If  later  the  expected  dividends  fail  to 
materialize,  the  market  for  the  shares  also  fails  and  their  value 
falls  precipitately.  In  new  countries  like  the  United  States, 
where  opportunities  seem  unlimited  and  where  enterprise  has  free 
play,  industrial  crises  are  more  frequent  and  severe  than  in  old 
conservative  countries. 


RELATION  OF  BANK  CREDIT  TO  PRICES  177 

Professor  T.  N.  Carver  traces  this  cause  of  overproduction 
still  further  back.    He  states  a  general  law  to  the  effect  that : 

A  slight  fluctuation  in  the  value  of  the  product  tends  to  pro- 
duce a  violent  fluctuation  in  the  value  of  the  establishment  produc- 
ing it.  Stated  in  still  more  general  terms,  the  value  of  producers' 
goods  tends  to  fluctuate  more  violently  than  the  value  of  con- 
sumers' goods.  This  law  is  capable  of  still  further  extension  when 
we  consider  that  producers'  goods  are  themselves  produced  by 
other  productive  agents.  .  .  .  The  law  might  therefore  be  ex- 
tended so  as  to  read,  that  the  farther  removed  the  producers'  goods 
are  from  the  consumable  product,  and  the  more  remotely  their 
value  is  derived  from  that  of  some  consumable  product,  the  more 
violent  the  fluctuations  in  the  value  tend  to  be.  This  would  be  the 
tendency  until  that  stage  was  reached  where  the  producers'  agents 
were  no  longer  especially  connected  with  one  particular  line  of  pro- 
duction, and  were  not  therefore  affected  merely  by  changes  in  price 
of  the  one  kind  of  consumable  product.  .  .  .  Not  every  rise  or 
fall  in  the  value  of  products  is  believed  to  be  permanent.  But 
where  the  high  or  low  price  of  a  product  continues  for  some  time, 
it  invariably  leads  to  a  belief  that  it  is  likely  to  continue;  and  this 
raises  or  depresses  the  price  of  the  productive  agent  out  of  propor- 
tion to  the  rise  or  fall  in  the  price  of  the  product.  .  .  .  Since 
their  willingness  to  invest  depends,  not  upon  the  value  of  the  gross 
product  of  the  productive  agent,  but  upon  the  excess  of  that  gross 
product  over  and  above  the  cost  of  using  the  agent, — which  excess 
....  fluctuated]  more  violently  than  the  total  value, — the 
instability  of  the  investors'  market  is  therefore  not  altogether  due 
to  psychological  changes  on  their  part,  but  in  large  degree  to  the 
objective  causes  which  affect  the  value  of  the  things  in  which  they 
invest. 

A  slight  rise  in  the  price  of  consumers'  goods  will  so  increase 
the  value  of  the  producers'  goods  which  enter  into  their  production 
as  to  lead  to  larger  investment  in  producers'  goods.  The  resulting 
large  market  for  producers'  goods  again  stimulates  the  production 
of  such  goods  and  withdraws  productive  energy  from  the  creation 
of  consumers'  goods.  This  for  the  time  tends  to  raise  the  price  of 
consumers'  goods  still  higher,  and  this  again  to  stimulate  further 
creation  of  producers'  goods.  There  is  no  check  to  this  tendency 
until  the  new  stocks  of  producers'  goods  begin  to  pour  upon  the 

VOL.    I — 12 


178  MONEY,  CREDIT,  AND  BANKING 

market  an  increased  flow  of  consumers'  goods.  This  tends  to 
produce  a  fall  in  their  value,  which  in  turn  produces  a  still  greater 
fall  in  the  value  of  producers'  goods;  and  so  the  process  goes. 
There  seems,  therefore,  to  be  a  fundamental  reason  for  the  perio- 
dicity of  industrial  depression,  which  can  only  be  removed  by  such 
complete  knowledge  and  understanding  of  the  situation  as  would 
enable  the  business  world  to  foresee  the  tendencies  and  take  meas- 
ures to  overcome  them. 3 

Psychological  Factors 

One  trade  is  bound  to  another  by  the  fact  that  they  are  each 
other's  customers.  High  profits  in  one  line  increase  the  demand 
for  the  products  of  another  line,  and  therefore  its  prices  and 
wages.  In  addition  to  this  bond,  the  lines  are  bound  together  by 
psychological  ties.  Men  on  a  market  act  as  men  do  in  a  crowd; 
they  do  not  make  their  estimates  independently  and  scientifically, 
but  are  much  influenced  by  the  general  opinion  or  the  opinion  of 
certain  leaders;  others  are  wholly  imitative,  particularly  the 
amateur  speculator.  For  this  reason  an«event  which  in  theory 
should  affect  market  values  but  slightly  may  actually  cause  rapid 
and  wide  fluctuations.  Therefore  overproduction  in  one  or  two 
lines,  an  event  that  is  inevitable  under  our  capitalistic  system, 
followed  by  declining  prices  and  security  values,  will  occasion  a 
bearish  opinion  that  will  infect  the  whole  industry  or  market. 
This  psychological  factor  not  only  broadens  the  scope  and  adds 
to  the  precipitancy  of  the  panic,  but  it  also  accelerates  the  boom 
preceding  a  panic  and  holds  the  business  world  in  a  state  of  de- 
pression sometimes  for  an  undue  period  after  the  panic. 

Periodicity  of  Panics 

Business  depression  is  characterized  by  low  production,  dull 
trade,  hesitant  investment,  hoarding,  low  prices,  liquidation,  low 
interest  rates,  and  unemployment.  How  long  the  depression  lasts 
depends  upon  the  degree  of  overproduction;  the  rejuvenation  of 

3  Quarterly  Journal  of  Economics,  May  1903,  p.  497. 


RELATION  OP  BANK  CREDIT  TO  PRICES  179 

business  cannot  begin  until  the  oversupply  is  consumed  and  the 
necessary  readjustments  have  been  made  in  production.  The 
depression  may  be  broken  by  some  fortuitous  event,  such  as  a 
presidential  election,  the  signing  of  a  treaty,  the  favorable  turn 
of  the  balance  of  trade,  and  the  like.  The  normal  time  required 
for  the  cycle  of  boom,  panic,  depression,  and  recovery  is  twenty 
years,  with  minor  disturbances  at  the  end  of  the  first  ten  years. 
A  certain  periodicity  in  panics  has  been  frequently  pointed  out, 
and  such  periodicity  is  exemplified  by  the  American  panics  of 
1819,  1837,  J847,  and  1857;  and  of  1873,  1884,  and  1893,  and 
1903,  the  more  severe  of  which  occurred  in  the  years  in  heavy 
type. 


CHAPTER  XI 

CLASSIFICATION    AND    FUNCTIONS    OF    BANKS 

Specialization  of  Bank  Functions 

Banking  institutions  are  specialized  dealers  in  and  guarantors 
of  credits.  The  evolution  of  our  system  of  credit  has  been  charac- 
terized by  the  same  division  of  labor  which  dominates  our  social 
and  economic  structure.  Not  only  have  credit  institutions  sepa- 
rated from  the  merchant  and  industrial  institutions,  but  the  credit 
institutions  have  themselves  specialized  on  the  basis  of  function. 
This  differentiation  of  functions  affords  the  most  useful  classifica- 
tion of  banks.  Banks  may  be  viewed,  of  course,  from  an  economic 
or  social  point  of  view  as  well  as  from  that  of  business.  The 
economist  and  sociologist  consider  the  services  of  the  bank  with 
reference  to  the  furtherance  of  human  welfare.  The  banker,  how- 
ever, thinks  of  his  bank  as  a  profit-making  institution;  he  may 
philosophize  on  its  economic  and  social  influences,  but  unless 
moved  by  a  high  sense  of  public  duty  he  is  prone  to  think  most  of 
dividends.  His  customers,  moreover,  are  likely  to  think  of  the 
bank  from  the  purely  business  point  of  view — as  an  institution 
from  which  to  secure  loans,  in  which  to  deposit  money,  and  by  the 
aid  of  which  securities  may  be  floated  and  estates  managed. 

Classification  by  Functions 

The  most  common  classification  of  American  banks  based  on 
bank  functions  makes  three  divisions,  namely: 
i.  Commercial  banks. 

2.  Investment  institutions,   including  savings  banks  and 

bond  houses  or  investment  banks. 

3.  Trust  companies. 

But  further  division  on  the  same  basis  is  possible.    The  New  York 

180 


CLASSIFICATION  OF  BANKS  l8l 

State  banking  law  has  special  sections  for  the  following  classes: 
state  and  national  (commercial)  banks,  federal  reserve  banks, 
credit  unions,  foreign  banking  corporations,  investment  bankers, 
investment  companies,  Land  Bank  of  the  State  of  New  York, 
personal  loan  brokers,  personal  loan  companies,  private  bankers, 
state  deposit  companies,  savings  and  loan  associations,  savings 
banks,  trust  companies,  discount  companies,  acceptance  houses, 
note-brokers,  and  others.  Indeed  the  subclasses  that  are  possible 
are  limited  in  number  only  by  the  number  of  functions  and  com- 
binations of  functions  open  to  such  institutions. 

Classified  as  to  source  of  authority  to  do  business,  banks  are 
commonly  grouped  as  federal  or  national,  state,  private,  and 
foreign.  Another  classification  is  into  parent  or  mother  bank, 
branch,  agency,  and  correspondent.  Still  another  is  into  joint- 
stock,  mutual,  private,  and  individual.  And  in  any  system  the 
banks  may  be  specified  as  central,  member,  or  non-member;  as 
bank  of  issue  or  non-issue;  as  reserve  city  bank,  central  reserve 
city  bank,  or  country  bank;  as  land  bank,  agricultural  bank, 
mercantile  bank,  industrial  bank,  and  so  forth. 

Functions  of  Commercial  Banks 

The  major  functions  of  commercial  banks  have  been  described 
in  Chapter  IV  as  the  testing  and  guaranty  of  credit,  and  the  ex- 
tension of  credit  by  means  of  notes,  deposits,  and  acceptances. 
Commercial  banks  extend  short-time  loans,  handle  short- time  mer- 
cantile paper,  receive  deposits  subject  to  check,  issue  bank  notes, 
issue  letters  of  credit,  and  accept  bills  drawn  upon  themselves. 
In  carrying  on  these  main  activities  many  incidental  services  are 
performed  for  customers.  In  a  circular  published  recently  a 
metropolitan  bank  advertised  "forty-three  separate  service 
divisions — all  working  for  a  single  object,  namely,  to  render  a 
powerful  and  well-balanced  banking  service."  In  their  competi- 
tion for  business,  banks  adapt  their  services  to  their  actual  and 
prospective   customers'   needs,    adding   feature   after   feature. 


182  MONEY,  CREDIT,  AND  BANKING 

In  this  point  of  service,  by  the  way,  there  is  probably  opportunity 
for  both  the  large  and  small  banks.  The  smaller  banks  can  render 
their  fewer  customers  services  that  are  probably  more  intimate  and 
personal  than  the  great  metropolitan  banks,  whereas  the  latter 
can  offer  facilities  more  powerful,  varied,  complete,  and  expert. 

The  accessory  and  minor  functions  of  commercial  banks  will 
be  discussed  in  detail  in  the  body  of  this  text.  The  nature  of  these 
functions  appears  in  the  statement  that  from  his  bank  the  busi- 
ness man  receives  the  ready  accommodation  of  a  loan  or  the 
prompt  cash  conversion  of  commercial  papers;  he  finds  it  conven- 
ient to  keep  his  money  and  make  his  payments  at  the  bank;  he  is 
advised  in  the  purchase  and  sale  of  securities  and  their  handling; 
the  bank  assembles  vast  credit  files  which  are  open  to  him;  his 
funds  are  transmitted  over  distances,  his  foreign  trade  is  facili- 
tated, his  business  operations  planned  and  guided  for  him. 

From  the  point  of  view  of  economics,  bank  credit  obviates 
the  use  of  metallic  money  and  conserves  the  metals  for  use  in  the 
arts;  it  facilitates  the  production,  movement,  and  exchange  of 
goods  more  effectually  even  than  money  does;  it  stabilizes  credit, 
resting  it  upon  long-established,  widely  extended,  conservatively 
managed  institutions.  The  banker  determines  the  personnel  of 
the  business  world,  by  extending  credit  to  persons  of  character 
and  capacity  and  by  choosing  as  debtors  those  who  have  either 
proved  abilities  or  give  reasonable  promise.  Capital  is  thus  di- 
verted into  channels  and  hands  where  it  is  most  productive  and 
most  useful  to  society.  The  bank  assembles  the  stray  and  hoarded 
funds  of  the  country  into  its  vaults  and  puts  them  to  productive 
use.  Capital  is  thereby  conserved.  The  benefits  of  thrift  are 
taught  and  the  importance  and  equity  of  keeping  contracts  to  the 
letter  are  brought  home  to  the  commercial  world. 

Specialization  of  Commercial  Banks 

Commercial  banks  specialize  in  loans,  adapting  their  services 
to  their  locality  or  to  a  special  clientele.    Some  carry  specializa- 


CLASSIFICATION  OF  BANKS  1 83 

tion  to  such  degree  as  to  relinquish  many  of  their  banking  func- 
tions. For  instance,  to  facilitate  the  production  and  marketing 
of  cattle,  "cattle  loan  companies"  conduct  a  banking  business  in 
the  primary  livestock  markets  and  production  centers.  Certain 
banks  in  close  touch  with  speculative  exchanges  cater  to  brokers 
and  commission  men.  Others  in  our  great  seaports  cater  to  for- 
eign trade  and  international  finance.  Devotion  to  a  limited  field 
of  operations  results  in  expertness  and  ability  to  perform  a 
particular  sort  of  loan  or  service  better  and  at  lower  rates  than  is 
possible  for  competitors  who  are  less  specialized. 

But  side  by  side  with  this  tendency  of  certain  banks  to  limit 
themselves  to  narrower  fields,  there  has  been  a  movement  in  the 
opposite  direction.  Banking  institutions  find  it  advisable  to  be 
able  to  perform  for  their  customers  all  the  financial  services  for 
which  they  have  need  rather  than  to  let  them  depend  in  part  on 
outsiders.  In  view  of  the  expense  of  organization  and  overhead 
which  the  bank  must  carry  in  any  event,  to  undertake  these 
additional  services  may  be  economically  very  desirable.  State 
and  national  banking  laws  have  hedged  the  banks  with  restric- 
tions on  their  field  of  operations,  but  commercial  banks  are  grad- 
ually developing  such  side  lines  as  long-term  and  agricultural 
loans,  acceptances,  trust  business,  insurance  agency,  loan  broker- 
age, safe  deposit  and  storage,  investment  buying  and  selling,  and 
so  forth.  The  trust  companies  in  the  several  states  are  pushing 
their  commercial  banking  departments,  and  national  banks  are 
being  permitted  by  federal  and  state  law  to  handle  trusts.  An 
identity  of  function  will  probably  not  be  developed  soon  but  the 
evolution  is  toward  a  close  approximation. 

Savings  Banks 

1.  Mutual  or  Trustee  Savings  Banks.  The  savings  bank  started 
as  a  mutual  savings  association  and  is  commonly  regarded  as  a 
benevolent  institution.  A  mutual  savings  bank  is  a  financial 
establishment  which  receives  deposits  up  to  a  fixed  maximum 


1 84  MONEY,  CREDIT,  AND  BANKING 

amount  from  individuals,  provides  safe-keeping  for  the  funds 
and,  having  aggregated  them,  invests  them  in  securities  declared 
by  the  state  legislature  legitimate  for  trust  funds;  the  interest 
from  these  investments,  after  the  bank's  expenses  are  deducted, 
accrues  to  the  depositors  in  proportion  to  their  deposits.  The 
relation  between  depositor  and  bank  is  one  of  trust ;  the  funds  of 
the  bank  are  held  by  its  officers  as  trustees;  the  assets,  profits, 
and  losses  are  distributed  ratably  among  depositors,  and  the 
officers  get  no  profits,  but  receive  trustee  fees.  The  rate  of  inter- 
est on  the  investments  is  generally  very  low,  for  the  reason  that 
safety  rather  than  earning  capacity  guides  the  legislature  in  defin- 
ing eligible  investments.  The  deposits  received  are  not  subject 
to  check,  nor  are  they  subject  to  withdrawal  except  by  pass-book 
and  due  notice  of  30,  60,  or  90  days,  varying  with  the  bank  and 
the  amount  to  be  withdrawn.  The  pass-book  constitutes  the  con- 
tract of  deposit;  the  terms  are  described  therein;  entries  and  signa- 
tures in  it  become  very  important  from  a  legal  point  of  view. 
The  depositor  is  moved  to  make  the  deposits  by  the  motive  of 
thrift  and  the  interest  inducement  offered  by  the  bank;  he  does 
not  expect  to  withdraw  them  soon  inasmuch  as  they  represent  his 
savings.  He  does  not  have  the  privilege  of  paying  by  check  which 
the  commercial  bank  accords  nor  does  he  get  short-term  accom- 
modation. The  savings  bank  invests  in  long-term  securities  and 
not  (though  recently  to  a  limited  degree  in  some  states)  in  short- 
term  commercial  paper;  its  deposits  turn  slowly  and  it  relies  on 
its  ability,  within  the  period  of  notice  of  intended  withdrawal  of 
deposits,  to  sell  its  securities  at  other  than  sacrifice  prices.  Mort- 
gages and  bonds  form  the  bulk  of  such  a  bank's  investments. 

2.  Joint-Stock  Savings  Banks.  In  the  West  and  South  the 
dominant  type  of  savings  bank  is  the  joint-stock  bank,  an  institu- 
tion which,  like  a  commercial  bank,  is  conducted  for  the  profit  of 
the  shareholders.  Deposits  are  received  as  in  other  savings  banks, 
but  instead  of  the  depositors  being  paid  a  net  return  from  the 
investments  above  expenses,  they  receive  a  definite  rate  of  inter- 


CLASSIFICATION  OF  BANKS  1 85 

est  as  arranged  at  the  time  of  making  their  deposits.  The  margin 
between  the  earnings  of  the  investments  and  the  interest  paid  on 
deposits  constitutes  the  sum  that  covers  expenses  and  profits  to 
the  stockholders.  These  net  profits  the  shareholders  divide  on 
the  basis  of  shares  owned. 

While  joint-stock  savings  banks  may  contribute  as  much  to  the 
economic  and  social  welfare  as  trustee  savings  banks,  they  are  pure- 
ly private  business  enterprises  and  not  eleemosynary  institutions. 
In  the  trustee  savings  bank  the  risk  of  high  or  low  earnings  and 
of  loss  of  principal  is  borne  by  the  depositor;  in  the  joint-stock 
bank  the  shareholders  assume  these  risks  and  guarantee  the  inter- 
est and  principal  to  the  depositor.  In  the  former  the  depositors, 
being  creators  of  a  trust,  have  the  control ;  in  the  joint-stock  bank 
they  are  simply  creditors  and  have  no  voice  in  its  management. 
The  mutual  type  prevails  in  New  England  and  the  eastern  states 
where  the  historical  and  social  conditions  are  favorable  to  it, 
where  the  communities  are  old,  sentiment  strong,  and  a  philan- 
thropic and  public-spirited  attitude  is  prevalent;  it  is  not  adapted 
to  the  West,  which  is  dominantly  commercial,  nor  to  the  South 
still  impoverished  from  the  Rebellion  and  lacking  on  the  whole  a 
thrifty  population.  The  trustee  who  starts  a  mutual  bank  gains 
no  financial  advantage  from  it;  in  fact,  he  assumes  a  large  risk  and 
responsibility  to  the  community.  He  must  be  a  man  of  highest 
type,  holding  the  unswerving  confidence  of  the  depositors,  not 
only  as  to  personal  character  but  also  as  to  business  capacity; 
he  acts  primarily  from  philanthropic  motives,  although  some 
lawyers  and  other  business  men  may  promote  mutual  banks  for 
the  purpose  of  gaining  clients. 

3.  Guaranty  and  Other  Types  of  Savings  Banks.  New  Hamp- 
shire is  unique  in  having  a  hybrid  type  of  savings  bank,  combining 
the  chief  features  of  the  two  previously  mentioned  types.  In- 
stead of  capital  stock  and  shareholders,  this  type  of  savings  bank 
has  "special  deposits"  and  "special  depositors."  It  pays  a  cer- 
tain stipulated  rate  of  interest  to  its  general  depositors,  and  any 


1 86  MONEY,  CREDIT,  AND  BANKING 

surplus  earnings  go  to  the  special  depositors.  The  special  deposits 
constitute  a  guaranty  fund  for  the  general  depositors  and  are 
limited  to  10  per  cent  of  the  total  deposits.  Except  for  their  name 
and  the  method  of  determining  their  amount,  these  special  de- 
posits have  all  the  characteristics  of  the  capital  stock  of  joint- 
stock  banks. 

There  are  many  other  kinds  of  savings  banks  which  are  too 
numerous  to  describe  here;  for  instance,  the  municipal  savings 
banks,  school  savings  banks,  postal  savings  banks,  and  various 
groups  of  co-operative  credit  institutions,  such  as  building  and 
loan  associations,  farmers'  co-operative  credit  societies,  and  the 
new  farm  loan  bank  system.  The  co-operative  credit  institutions, 
while  formed  primarily  to  provide  on  their  joint  credit  long-term 
credits  on  realty  at  lower  rates  than  the  co-operators  could  ob- 
tain on  their  individual  credit,  tend  to  fulfil  much  the  same  social 
and  economic  ends  as  other  savings  banks. 

Functions  of  Savings  Banks 

The  essential  economic  and  social  functions  of  savings  banks 
are  three  in  number,  as  follows : 

i .  They  assemble  the  capital  of  the  community,  conserve  the 
idle  wealth,  and  having  aggregated  it  into  sizable  funds,  loan 
it  to  business  enterprisers. 

2.  They  add  to  the  peace  and  comfort  and  available  consump- 
tion of  society  by  providing  a  safe  outlet  for  the  funds  of  those 
who  have  the  will  and  capacity  to  save  but  do  not  have  the 
ability  either  to  use  the  funds  industrially  themselves  or  to  invest 
them  with  safety  and  profit. 

3.  They  promote  thrift  more  than  any  other  financial  in- 
stitution. 

The  prudent  investment  of  interest  and  accumulated  princi- 
pal, which  together  constitute  savings,  lessens  profligacy,  pro- 
vides against  the  adversities  of  old  age  and  sickness,  helps  the 
thrifty  to  buy  a  home  and  to  enjoy  better  living  conditions,  builds 


CLASSIFICATION  OF  BANKS  1 87 

up  independence  and  stability  of  character,  and  improves  the 
social  and  political  life  of  the  community. 

Functions  of  the  Bond  House  and  Investment  Bank 

Whereas  savings  banks  aim  to  assemble  funds  for  the  pur- 
chase of  investments,  and  whereas  the  bond  houses  or  invest- 
ment banks  are  concerned  with  the  sale  and  distribution 
of  securities,  both  promote  investment  from  the  opposite 
end. 

In  marketing  securities,  three  groups  of  institutions  are  suc- 
cessively engaged:  The  securities  are  purchased  by  one  group, 
are  underwritten  by  another,  and  are  distributed  among  ultimate 
buyers  by  a  third.  These  functions  overlap,  it  is  true,  and  in 
some  instances  one  house  may  perform  all  three  of  them,  and  the 
bond  house  may  operate  in  any  or  all  of  these  ways. 

1.  Purchasing  Securities.  The  houses  which  buy  first  hand 
the  largest  blocks  of  securities  are  relatively  few  in  number  and 
strong  financially,  with  central  offices  in  New  York,  Philadelphia, 
Boston,  or  Chicago.  There  are,  of  course,  in  these  and  other  cities 
many  houses  which  are  competent  to  handle  somewhat  smaller 
blocks  of  securities.  Institutions  which  buy  securities  on  a  large 
scale  must  command  large  resources,  occupy  a  position  of  finan- 
cial influence,  and  have  a  record  of  successes  which  will  assure 
the  company  issuing  the  securities  of  the  success  of  the  flotation. 
Such  houses  determine  the  direction  of  industrial  and  commercial 
development  and  the  selection  of  the  personnel  of  business  enter- 
prises worthy  of  financial  support.  They  may  act  either  inde- 
pendently or  in  conjunction  with  others. 

The  promoter  brings  his  proposition  to  one  of  the  financial 
houses  at  a  time;  if  his  negotiations  fail  he  approaches  another; 
but  he  will  not  find  the  financial  houses  actively  competing  with 
one  another,  nor  do  they  actively  bid  for  his  proposition.  Ac- 
tive competition  by  bond  houses  might  result  in  reckless  extensions 
of  credit  and  overfinancing;  the  bankers  prefer  to  act  in  a  more 


188  MONEY,  CREDIT,  AND  BANKING 

professional  capacity  and  to  select  their  clients  with  an  eye  to  an 
intimate,  confident,  and  permanent  relationship. 

A  few  years  ago  the  cry  arose  that  the  financial  houses 
constituted  a  "money  trust,"  denying  financial  assistance  to 
warrantable  business  undertakings  mainly  because  the  latter  in- 
terfered or  competed  with  the  vested  interests.  The  extensive 
investigations  of  the  Pujo  Committee  failed  to  make  out  a  con- 
clusive case  for  these  allegations. 

In  purchasing  a  block  of  municipal  securities  a  preliminary 
investigation,  unless  it  is  the  issue  of  a  well-known  municipality, 
is  made  by  an  agent  who  inquires  into  the  physical  and  financial 
condition  of  the  city  to  determine  its  ability  and  willingness  to 
meet  its  present  and  prospective  obligations. 

The  securities  issued  by  business  corporations  are  usually 
submitted  to  the  bond  houses  by  a  representative  of  the  company 
or  by  a  promoter.  The  bond  houses,  except  under  very  favorable 
conditions,  refuse  to  handle  securities  of  a  business  with  which 
they  are  unfamiliar.  They  reject  issues  in  excess  of  the  physical 
value  of  the  mortgaged  property  and  they  likewise  refuse  securi- 
ties of  corporations  with  narrow  margins  of  net  earnings  above 
fixed  charges,  and  of  corporations  owned  or  operated  by  men  of 
low  business  morality. 

If  a  favorable  price  can  be  agreed  upon,  accountants,  engineers, 
and  investigators  are  sent  to  make  a  thorough  examination  of  the 
conditions,  and  after  the  proposition  is  finally  accepted  the  bond 
house  may  insist  upon  having  representation  upon  the  board  of 
directors  until  the  securities  are  disposed  of.  Some  houses  finally 
handle  only  securities  of  well-established  earning  power.  This 
insistence  upon  high  quality  reacts  favorably  upon  corporate 
finance  in  general. 

2.  Underwriting.  A  bond  house  which  has  bought  a  big  block 
of  securities  endangers  itself  by  the  high  concentration  of  risk; 
this  risk  is  usually  distributed  by  having  the  issue  underwritten 
by  a  group  of  banks  through  what  is  known  as  a  "  syndicate  agree- 


CLASSIFICATION  OF  BANKS  1 89 

ment."  There  are  four  basic  types  of  syndicate  agreements,  with 
several  variations.  It  will  suffice  to  illustrate  but  one  type:  Sup- 
pose that  a  bond  house  takes  over  the  bond  issue  of  a  corpora- 
.tion  at  97.5  and  that  a  syndicate  is  formed,  the  members  of  which 
are  offered  and  agree  to  take  parts  of  the  issue  at  98.29  in  case 
the  public  does  not  take  them  at  99.04.  The  bond  house  might  be 
successful  in  closing  out  the  issue  directly  to  purchasers  at  99.04, 
but  rather  than  run  the  risks  attendant  on  underwriting  so  large 
a  block,  it  is  content  to  make  a  smaller  margin  of  profit  through 
offering  the  securities  to  the  underwriting  syndicate.  If  the  public 
absorbs  the  securities  at  99.04,  the  underwriters  make  $4  Per 
cent  for  having  assumed  the  risk;  but  if  the  market  offers  only 
96  the  underwriters  take  them  over  at  98.29,  and  thus  tie  up  their 
funds  indefinitely  or  until  the  market  rises.  The  members  of  the 
underwriting  syndicate  co-operate  to  establish  and  maintain  the 
market  for  the  issue.  Bond  houses  like  to  participate  in  syndi- 
cates so  as  to  diversify  their  security  offerings  and  be  able  to  offer 
such  a  variety  of  investments  as  will  be  sure  to  attract  and  retain 
customers. 

3.  Distributing  Securities.  Bond  and  brokerage  houses  prefer 
to  sell  large  issues  at  small  commissions  rather  than  small  issues 
at  larger  commissions.  The  expense  of  investigating  a  small  issue 
is  nearly  as  heavy  as  a  large  issue ;  the  selling  expense  per  share  is 
likely  to  be  smaller  in  the  case  of  the  large  issue  as  it  can  be  sold 
in  larger  blocks;  and  the  large  issue  probably  comes  from  a  larger, 
better  known  institution  and  will  therefore  sell  more  easily.  The 
commission  rates  vary  widely,  the  general  range  being  i}4  to  10  per 
cent;  the  chief  factors  determining  the  rate  are  the  size  of  the  issue, 
the  condition  of  the  market,  the  borrowing  corporation,  and  the 
publicity  that  will  be  required.  In  addition  to  the  commission, 
the  borrowing  corporation  must  pay  legal  expenses  and  fees  to 
accountants,  intermediary  brokers,  and  others,  which  expenses 
may  run  to  a  high  figure. 

Some  bond  houses  have  developed  a  clientele  to  whom  they 


190  MONEY,  CREDIT,  AND  BANKING 

sell  by  mail;  some  sell  through  local  independent  bankers  on  a 
commission  basis;  some  have  developed  a  great  sales  organization 
and  reach  old  and  new  customers  by  advertisements,  circulars, 
and  traveling  salesmen.  A  selling  campaign  may  be  very  exten- 
sive and  highly  organized;  the  more  underwriters  the  more  widely 
dispersed  will  the  sales  be.  The  buyers  are  insurance  companies, 
banks  in  smaller  cities,  secondary  syndicates,  individual  trustees 
and  estates,  trust  companies,  savings  banks,  and  individuals. 

The  bond  house  or  syndicate  manager  undertaking  to  market 
an  issue  of  securities  may,  particularly  if  the  issue  is  a  large  one, 
have  the  securities  listed  on  the  stock  exchange  and  try  to  sell 
part  of  the  issue  through  that  avenue.  Thus  a  ready  market  is 
at  once  established  and  many  people  whose  names  do  not  appear 
in  the  lists  of  prospects  of  the  various  bond  houses,  or  who  prefer 
to  buy  or  sell  through  the  exchange  rather  than  "over  the  coun- 
ter," may  be  attracted  and  buy  the  securities.  The  sellers  then 
proceed  "  to  make  a  market,"  by  creating  a  volume  of  transactions 
sufficiently  large  to  draw  the  interest  of  brokers  and  speculators. 
The  syndicate  buys  and  sells  the  securities  and  otherwise  manipu- 
lates the  market,  in  this  way  controlling  the  price  and  gradually 
unloading  the  securities  on  the  investing  and  speculative  public. 
Meanwhile  a  campaign  of  publicity  is  being  conducted  in  the 
financial  press  and  daily  newspapers. 

Having  investigated  carefully  the  history,  physical  property, 
earning  capacity,  present  and  prospective  business  policy,  and 
organization  of  the  corporation  before  undertaking  to  market  its 
securities,  the  bond  house  is  in  a  position  to  recommend  them  to 
its  customers.  The  good-will  of  a  representative  bond  house 
achieved  by  conservative  practice,  good  counsel,  and  painstaking 
service,  would,  of  course,  be  endangered  by  recommending  securi- 
ties which  prove  to  be  of  poor  quality,  and  therefore  customers 
come  to  put  implicit  confidence  in  its  advertisements,  circulars, 
and  daily  news  sheets.  Bond  houses  thus  function  as  advisors 
and  directors  of  investment. 


CLASSIFICATION  OF  BANKS  191 

Though  the  policy  of  the  bond  houses  in  protecting  their  cus- 
tomers varies  greatly,  it  is  not  unusual  for  them  to  contract  explic- 
itly to  make  good  their  counsels  and  recommendations  as  to  pur- 
chases, and  if  the  price  of  securities  recommended  declines  below 
the  selling  price,  the  house  stands  ready  to  repurchase  and  thus 
protect  the  buyer.  The  buyer  is  often  protected,  however,  quite 
as  much  by  the  moral  responsibility  which  the  house  feels  towards 
its  client  as  by  an  explicit  contract. 

Banking  and  Other  Operations  of  Bond  Houses 

The  intimate  relations  between  a  bond  house  and  its  customers 
are  furthered  by  certain  of  its  banking  operations.  A  special 
department  is  established  for  the  safe  deposit  of  funds  which, 
together  with  accruals  of  interest  and  additions  from  time  to 
time,  the  depositor  purposes  to  invest  in  securities  offered  by  the 
bond  house.  The  banking  department  also  makes  loans  to  cus- 
tomers who  wish  to  purchase  securities  but  who  have  not  sufficient 
funds  to  pay  in  full  at  the  time  of  purchase.  In  conjunction  with 
the  deposits  destined  for  purchase  of  securities,  the  banking  de- 
partment may  accept  other  deposits  subject  to  check;  this  service 
is,  however,  mainly  incidental.  It  would  seem  best  for  the 
investment  market  and  the  commercial  bank  market  to  be  kept 
relatively  distinct.  Some  investment  banks  by  adding  service  to 
service  have  become  general  banking  institutions,  handling  securi- 
ties, savings,  trusts,  and  deposits. 

A  further  activity  of  bond  houses  is  to  act  as  fiscal  agents  for 
business  corporations  and  bodies  politic.  The  payment  of  divi- 
dends, interest,  and  principal  on  stocks  and  bonds,  the  flotation  of 
their  securities  and  their  financial  advertising  are  all  matters 
entrusted  to  well-known  bond  houses  in  the  central  markets. 
Undoubtedly  this  arrangement  improves  the  financial  stability  of 
the  country,  for  in  performing  these  operations  of  corporate 
finance  the  bond  houses  seek  to  build  and  maintain  a  good-will 
which  less  permanent  promoters  would  fail  to  consider. 


192  MONEY,  CREDIT,  AND  BANKING 

General  Functions  of  Trust  Companies 

A  trust  is  something  committed  to  another  person's  care  for 
use  or  management  and  for  which  an  account  must  be  rendered. 
The  original  and  essential  function  of  a  trust  company  was  to 
accept  and  handle  trusts  of  a  business  nature.  To  execute  trusts 
efficiently,  however,  the  trust  company  found  it  expedient  to 
undertake  many  lines  of  collateral  business,  thus  adding  function 
after  function  to  its  province  until  today  it  represents  the  most 
inclusive  and  complete  financial  institution. 

A  representative  trust  company  performs  the  following  general 
functions : 

i.  Banking   functions:    savings   and    commercial   banking 
operations. 

2.  Trust  and  agency  functions: 

(a)  For  individuals:  private  agreements,  probate,  in- 

vestment, real  estate,  and  insolvency  operations. 

(b)  For  corporations:  trustee  of  mortgages  and  funds, 

transfer  agent,  registrar,  corporate  reorganiza- 
tion and  financing  operations. 

3.  Insurance  and  safe-deposit  functions. 

Advantages  of  Corporate  over  Individual  Trustee 

A  trust  company  can  perform  the  various  functions  of  trustee 
better  than  an  individual.  As  a  corporation  its  existence  is  not 
limited,  so  that  it  can  carry  through  to  the  end  any  trusts  com- 
mitted to  it,  whereas  the  individual  trustee  may  die  or  become 
incompetent,  making  it  necessary  to  instal  another  trustee,  with 
incident  delay  and  expense.  The  convenience  of  the  creator  of 
the  trust  and  the  public  is  enhanced  when  a  trust  company  acts  as 
trustee  rather  than  an  individual,  since  it  has  a  regular  place  of 
business,  well  known  and  open  every  business  day.  It  has  all  the 
facilities  for  executing  trusts  efficiently — an  organization,  expert 
officers,  a  clerical  staff,  a  legal  department,  a  good  bookkeeping 
and  auditing  system,  safe-deposit  vaults,  a  wide  clientele,  and 


CLASSIFICATION  OF  BANKS  193 

so  forth.  To  this  work  it  gives  its  almost  exclusive  attention, 
whereas  an  individual  trustee  is  prone  to  make  his  trust  secondary 
to  his  own  business.  Furthermore,  the  trust  company  is  expert  in 
the  law  of  trusteeships  and  has  had  long  experience  in  handling 
them;  its  customers  who  have  created  trusts  with  it  get  the 
benefit  of  its  legal  advice  and  investment  ability,  and  thus  the 
income  from  the  trust  is  likely  to  be  higher  and  the  expenses  lower ; 
and  the  trust  company  is  able  to  make  temporary  loans  to  the  ad- 
vantage and  preservation  of  the  estate.  Finally,  the  trust  is  much 
safer  in  the  hands  of  a  company,  which  executes  the  estate  in 
an  impersonal  way,  free  from  the  personal  prejudices  and  biases 
common  to  individual  trustees;  which  also  provides  a  capital  and 
surplus  to  protect  its  customers;  and  which  desires  to  perpetuate 
the  good-will  of  the  institution.  Such  influences  as  these  make 
for  additional  security. 

Trust  Functions  for  Individuals 

Trusts  undertaken  for  individuals  are  of  various  kinds  and 
arise  for  numerous  reasons.  Persons  who  feel  themselves  in- 
competent to  care  for  their  estates,  travelers,  absentee  property- 
owners,  endowed  charities  or  bequests,  and  others,  commit  their 
properties  to  the  care  and  management  of  trust  companies.  Trust 
companies  act  as  custodians  of  life  insurance  policies,  collect  the 
proceeds  of  the  policies,  and  pay  them  as  annuities  to  beneficiaries. 
In  all  such  trusts  the  trustee's  fees  are  stated  in  the  trust  con- 
tract, and  the  funds  are  kept  distinct  from  the  trustee's  own  as- 
sets and  are  held  in  the  name  of  the  trust  company  as  trustee. 

In  many  states  the  trust  company  is  empowered  by  law 
to  act  as  executor,  administrator,  trustee,  guardian,  and  con- 
servator. An  executor  is  a  person  appointed  by  the  terms  of 
a  will  to  take  and  execute  an  estate  according  to  the  terms 
of  that  document.  An  administrator  is  a  person  appointed  by 
the  probate  court  to  take  and  execute  according  to  the  inherit- 
ance laws  of  the  state  an  estate  of  one  who  has  died  intestate. 


194  MONEY,  CREDIT,  AND  BANKING 

An  "administrator  with  the  will  annexed"  is  a  person  appointed  by 
the  court  to  take  and  execute  an  estate  when  the  deceased  did  not 
name  an  executor  in  the  will,  or  when  the  executor  named  dies, 
refuses  to  act,  or  is  incapacitated  from  acting.  The  trust  com- 
pany may  serve  in  any  of  these  capacities  and  in  doing  so  take 
charge  of  the  estate,  subject  to  the  supervision  of  the  court,  to 
which,  after  the  final  distribution  of  the  estate  according  to  the 
will  or  the  state  inheritance  laws,  the  company  makes  an  itemized 
report  of  all  receipts  and  expenditures  under  the  trust.  The  trust 
company  may  be  appointed  a  guardian  to  care  for  the  estates  of 
minors,  or  a  conservator  to  care  for  the  estates  of  insane,  idiots, 
habitual  drunkards,  spendthrifts,  or  others  incapable  of  looking 
after  their  own  affairs.  All  such  duties  are  carried  out  under  the 
surveillance  of  the  court,  to  which  also  reports  are  made.  The 
fees  may  be  fixed  by  law  or  by  the  court.  State  statutes  generally 
permit  trust  companies  to  act  as  depositories  for  court  funds  and 
for  others  acting  as  executors  and  the  like. 

The  conduct  of  the  trust  functions  of  a  trust  company  gives 
occasion  for  the  investment  and  reinvestment  of  trust  funds; 
and  the  trust  company  has  funds  of  its  own  to  invest.  To  carry 
out  these  investment  operations  a  special  department  is  de- 
veloped which  deals  in  high-grade  securities  for  itself,  its  clients 
who  have  established  trusts  with  it,  and  other  customers,  and  func- 
tions as  a  bond  house.  One  favorite  line  of  investments  is  mort- 
gages or  debentures  issued  by  mortgage  bond  houses,  or  the  trust 
companies  may  issue  such  bonds  themselves  and  sell  them  to 
their  customers.  Under  investment-deposit  agreements,  deposits 
received  from  customers  are  invested  in  securities  which  are  held 
in  trust  for  the  depositors. 

Another  type  of  service  is  the  care  of  real  estate  committed 
to  a  trust  company  by  private  agreement,  by  will,  or  by  appoint- 
ment of  court.  This  line  of  activity  may  develop  into  a  real  estate 
business  engaged  in  the  purchase,  sale,  and  renting  of  real  estate 
on  commission. 


CLASSIFICATION  OF  BANKS  195 

Trust  companies  are  permitted  in  some  states  to  act  as  as- 
signees, receivers,  and  trustees  in  bankruptcy.  An  assignee  or 
trustee  in  bankruptcy  cares  for  the  just  distribution  of  the  assets 
of  insolvent  persons,  firms,  or  corporations  among  their  creditors. 
The  assets  are  taken  over,  some  or  all  of  them  are  converted  into 
cash,  the  preferred  claims  are  paid,  and  the  rest  of  the  assets  are 
distributed  among  the  creditors  on  the  basis  of  their  claims.  As- 
signees and  trustees  are  accountable  to  the  court  having  juris- 
diction. 

A  receiver  is  a  person  or  a  corporation  appointed  by  the  court 
to  take  charge  of  a  property  in  dispute.  If  the  shareholders  of  a 
company  or  the  partners  of  a  firm  are  dissatisfied  with  its  manage- 
ment the  court  may  be  asked  to  handle  the  property  until  the 
dispute  is  settled.  Sometimes,  although  a  company  is  insolvent, 
the  prospect  for  early  rehabilitation  may  be  good  and  the  court 
may  appoint  a  receiver  to  handle  the  property  during  the  period 
of  recovery.  On  the  other  hand,  the  company  may  be  so  insolvent 
as  to  be  hopeless,  and  the  receiver  may  be  appointed  to  cut  down 
fixed  charges,  assess  the  present  holders,  borrow  funds,  and  put 
the  reorganized  company  on  its  feet  again.  The  trust  company, 
by  reason  of  its  experience,  good  credit,  and  financial  responsibil- 
ity, is  well  fitted  to  act  in  any  of  these  cases. 

Trust  Functions  for  Corporations 

A  trust  company  commonly  acts  as  trustee  under  the  trust 
deed  or  mortgage  securing  an  issue  of  bonds.  It  certifies  to  the 
regularity  of  the  issue  and  to  the  genuineness  of  the  document, 
but  does  not  guarantee  the  value  or  payment  of  the  bond.  In 
this  capacity  the  company  acts  for  the  interest  of  the  bondholders, 
and  in  case  of  default  of  the  issuing  company  it  could  foreclose  on 
the  property  covered  by  the  deed  or  mortgage. 

Another  trust  activity  is  to  act  as  fiscal  agent  for  states, 
municipalities,  railroads,  and  industrials,  handling  the  payments 
relating  to  the  bonds,  coupons,  interest,  dividends,  taxes,  acting 


196  MONEY,  CREDIT,  AND  BANKING 

as  depository  for  the  above  corporations,  receiving  subscriptions 
to  their  securities,  and  delivering  the  issues. 

Trust  companies  act  as  transfer  agents  for  stocks  and  regis- 
trars for  stocks  and  bonds,  their  duty  being,  in  that  connection, 
to  prevent  the  fraudulent  overissue  of  securities.  The  transfer 
agent  cancels  old  certificates  of  stock  and  issues  new  ones  in  the 
names  of  the  new  owners.  Bonds  are  registered  as  to  principal  or 
interest,  or  both,  and  usually  the  trustee  of  the  mortgage  un- 
derlying the  bonds  acts  also  as  registrar  of  the  bonds. 

Other  important  operations  of  trust  companies  are  connected 
with  corporate  reorganization  and  financing.  This  is  a  risky  line 
of  service  and  if  the  trust  company  is  to  maintain  its  good-will  it 
must  handle  only  conservative  propositions.  When  charged  with 
such  work  the  trust  company  determines  upon  a  plan  of  reorgan- 
ization, recalls  the  outstanding  certificates,  distributes  the  new 
ones,  makes  assessments,  and  manages  the  reorganized  company 
until  it  is  an  assured  success.  When  a  new  enterprise  is  to  be  fi- 
nanced, the  trust  company  investigates  the  concern  and  the  value 
of  its  physical  and  other  assets,  undertakes  the  sale  of  its  securities, 
and  acts  as  a  regular  investment  banker. 

Insurance  and  Safe-Deposit  Functions 

Some  few  states  permit  trust  companies  to  do  a  fidelity  insur- 
ance and  title  insurance  business  similar  to  that  done  by  regular 
bond  or  surety  companies.  Fidelity  insurance  is  devoted  chiefly 
to  acting  as  surety  for  the  honesty  and  fidelity  of  officers  and 
employees  holding  positions  of  trust  and  responsibility.  Such  an 
arrangement  is  better  for  all  concerned  than  to  have  friends  go 
surety  for  the  person  bonded,  for  the  person  signing  the  bond,  and 
for  the  security  afforded  the  beneficiary  named  in  the  bond.  The 
fidelity  company  receives  compensation  for  its  service,  assumes 
the  risk  as  an  actuarial  business  matter,  and  protects  the  bene- 
ficiary with  its  known  financial  responsibility.  Title  insurance  is 
an  agreement  of  the  trust  compay  to  defend,  at  its  own  expense, 


CLASSIFICATION  OF  BANKS  197 

all  litigation  directed  against  the  title  insured  by  it,  and  in  case  of 
unsuccessful  defense  to  bear  losses  up  to  the  full  sum  insured  for. 

Trust  companies  also  do  a  safe-deposit  business,  maintaining 
vaults  so  constructed  as  to  be  proof  alike  against  burglars  and 
mobs,  fire,  and  water.  Boxes  are  rented  for  the  keeping  of  money, 
jewels,  and  valuable  papers  and  access  thereto  is  given  only  when 
the  vault  guard  is  in  attendance. 

While  there  are  other  minor  functions  performed  by  trust 
companies,  those  just  described  are  the  most  important  and  indi- 
cate the  wide  variety  and  complexity  of  the  trust  banking  business. 


INDEX 


Acceptances,  bank, 

accepting  vs.  lending,  157 
definitions,  67 
limitation  on,  156 
protection  of,  154-157 
Accommodation    based    on    deposit 

balance,  70 
Assessments,  provision  of  guaranty- 
fund  by,  132 
Assets, 

earning,  relation  to  secondary  re- 
serve, 150 
general,  protection  of  bank  notes 
by,  113 

B 

Bank  acceptance  (See  "Acceptance, 

bank") 
Bank  capital  (See  "Capital,  bank") 
Bank  credit  (See  "Credit,  bank") 
Bank  notes, 

Canadian  system  of,  124-128 

convertibility,  112 

currency    vs.    banking    principle, 
109,  no 

definition,  67 

deposits,    similarity    and    dissimi- 
larity to,  105-108 

effect  of  issue  on  bank  statement,  83 

effect  on  inflation,  106 

elasticity  of,  116 

English  system  of,  120,  121 

French  system  of,  120 

German  system  of,  122,  123 

nature  of,  105 

origin,  83 


Bank  notes — Continued 
protection  of, 

existing  systems  of,  1 19 
maintenance  of  elasticity,    117- 

119 
maintenance  of  parity,  112 
objects  in  view,  112 
provisions  for  ultimate  payment, 

II3-II5 
reasons  for  special,  108 
uncovered  issue  of,  121 
United  States,  issues  of,  128 
Bank  statement, 

effect  of  operations  on, 
borrowing  funds,  99 
capital  expenditures,  97 
clearings  and  collections,  97 
deposits  with  correspondents,  96 
distribution  of  earnings,  98 
issue  of  bank  notes,  98 
issue  of  certificates  of  deposit,  97 
issue  of  letters  of  credit  and  ac- 
ceptance, 99 
overdrafts,  98 
payment  of  expenses,  97 
sale  of  drafts,  97 
scaling  down  overvaluation,  99 
form  of,  99 
Banking, 
commercial  functions  of,  84,  87 
relation  to  money,  3 
Banking    principle  (See    "Currency 

principle") 
Banks, 
classification  of,  180,  181 
commercial, 
functions  of,  181,  182 


199 


200 


INDEX 


Banks — Continued 

commercial — Continued 
similarity  of  functions,  183 
specialization,  182 
savings  (See  "  Savings  banks") 
Bars,  bullion,  24 
Barter, 

money  economy,  4 
nature  of,  161 
Bills  payable, 
definition  of,  67 
protection  of,  158,  159 
substitutes  for,  159 
Bills  receivable,  collateral  for  inter- 
bank loans,  158,  159 
Bimetallism, 

arguments  for  and  against,  10,  11 
definition  of,  10 
effect  of  two  legal  tenders,  13 
mint  and  market  ratios,  12 
operations  of,  illustrated,  12 
Bland-Allison  Act  of  1873,  20 
Bond  house, 

banking  department  of,  191 

business  of  promoter  with,  187 

compensation  of,  189 

fiscal  agents,  191 

functions  of,  187 

methods  of  distributing  securities, 

189,  190 
purchase  of  securities  by,  187,  188 
responsibility  of,  190,  191 
underwriting  by,  1 88 
Branch  banks  in  Canada,  124 
Brassage,  definition  of,  9 
Brokers,  note,  effect  on   commercial 

credit,  89 
Bullion  bars,  24 


Canada, 

bank  circulation  redemption  fund, 

126 
bank  note  system  of,  124-128 


Canada — Continued 
branch  banks,  124 
Canadian     Bankers'     Association, 

125 

Dominion  notes,  125 
notes  of  failed  banks,  126 
redemption  offices,  127 
reserve  notes,  124 
Capital, 
bank, 

nature  of,  84 
subscription  of,  84 
surplus,  85 

undivided  profits,  85,  86 
contributions  by  banks,  88-90 
Carver,T.  N.,on  causes  of  overproduc- 
tion, 177 
Cash, 

definition  extended  in  Germany,  122 
deposit  of,  67,  68 
items,  definition  of,  68 
motives  in  depositing,  69 
Certificates, 
gold,  58 
gold  order,  59 
nature  of,  49,  50 
method  of  issuance,  59 
methods  of  redemption,  60,  61 
silver,  58 
Clearing  house, 
country,   103 
economies  of,  102 
nature  of,  102 
Clearings, 

clearing  house,  102,  103 
factors   determining   time  of   col- 
lections, 100 
method  of  presentment,  101 
Coinage    (See  also  "Free  coinage"; 
"Subsidiary  coinage") 
Act  of  1792,  18 
Act  of  1873,  19 
activity  of  mint,  30 
bimetallism,  10-13 


INDEX 


201 


Coinage — Continued 

Bland-Allison  Act  of  1878,  20 

brassage,  9 

bullion  bars,  24 

definition  of,  7 

fineness  of  coins,  28 

free,  10 

gold  coins  in  circulation,  25 

gold  shipments,  25 

Gold  Standard  Act  of  1900,  22 

gratuitous,  9 

history  of,  18 

history  of  mint  ratio,  18 

minor  coins,  23 

monometallism,  10-13 

nickel  and  copper  coins,  28 

Pittman  Act  of  1918,  22,  23 

seigniorage,  9,  10 

Sherman  Silver  Act  of  1890,  21 

Silver  coins  in  circulation,  26,  27 

silver  dollar,  19-21 

state  monopoly,  8 

subsidiary,  17 

token  coins  minted,  31 

United  States  Mint,  32,  33 

weight  of  coins,  28 
Collateral  inter-bank  loan,  158,  159 
Collections  (See  also  "Clearings") 

out-of-town  (country),  103 
Commercial     banks  (See     "Banks, 

commercial") 
Compensated  dollar,    172,   173   (See 
also  "  Monetary  standard,  mul- 
tiple ") 
Convertibility, 

bank  notes,  1 12 

character  of  secondary  reserve,  151 

government  convertible  paper,  50 

value  of  inconvertible  money,  52 

vs.  redeemability,  50 
Credit, 

bank, 

forms  of,  66 

origin  of  deposits,  66 


Credit — Continued 
bank —  Con  tinued 

protection  of,  against  insolvency, 
no,   III 

relation  of,  to  prices,  162 

specialization  of,  66 
characteristics  of, 

contract  element,  36,  37 

element  of  confidence,  35 

element  of  time,  35 

oral  vs.  written,  36 

personal  element,  38 

stated  in  terms  of  money,  37 

substitute  for  money,  37 

tendency  to  circulate,  37 
circulation  of, 

basis  of  its  circulation,  46 

credits   having  general   circula- 
tion, 46 

credits   having    limited    circula- 
tion, 46 

vs.  metallic  money,  45 
classification  of, 

commercial,  40,  41 

consumptive  or  personal,  42 

financial,  41 

indorsed,  40 

public  and  private,  43 

secured,  39 

time  and  demand,  42 
defined,  3,  48 
effect  of  time  element  on  value  of, 

42 
effect  on  transferability  of  wealth, 

44 

government,  reasons  for  wide  ac- 
ceptability, 48 

guaranty  of,  75,  76 

indorsement  of,  40 

investment,  contributed  by  com- 
mercial banks,  89,  90 
'  markets,  banks  as,  88 

relation  of  wealth  to,  43,  44 

relation  to  interest,  44 


202 


INDEX 


Credit — Continued 

substitution  of  debtor,  40 
transactions  involving,  38 

Crisis,  industrial  causes,  173,  174 

Currency      (See    also     "Coinage"; 
"Elasticity";  "Gold";  "Green- 
backs"; "Money";  "Silver") 
elasticity  of,  119 
gold  coins  in  circulation,  26 
money  in,  in  United  States,  62 
silver  coins  in  circulation,  26 
subsidiary  silver  coins  in  circula- 
tion, 26 

Currency  principle, 
statement  of,  109 
vs.  banking  principle,  109,  no 


Darlehnkassenscheine,  123 
Deposits, 
and  bank  notes, 

dissimilarity,  107 

similarity,  105 
cash,  nature  of,  67,  68 
creation  by  discounts,  72,  73 
creation  by  loans,  71,  72 
definition  of,  66 
effect  on  price  level,  162 
guaranty  of, 

adverse  effect  on  banking,  141, 
142 

arguments  for,  138 

assessment  provision,  132 

cost  of,  141 

effect  on  guaranteed  banks,  141 

effect  on  runs  and  panics,  139, 
140 

form   of   assessment   insurance, 

143 
Kansas  system  of,  135-137 
methods,  130 
Oklahoma  system  of,  131 
responsibility  of  state  for,  138, 139 


Deposit  s — Continued 
guaranty  of — Continued 

safety  fund  plan,  131 

savings  and  commercial,  140 
limitations  of  cash,  80 
limitations  on  extension,  76-80 
limited  by  adverse  clearing  house 

balances,  76-80 
limited  by  reserve  ratio,  78-80 
methods  of  origin  of,  66 
motives  in  depositing  cash,  69 
protection  of, 

bank  notes  favored,  129 

guaranty  of,  129 

methods  of,  1 29 

ratio  to  loans,  81 

special,  in  United  States,  129 
Discount  (See  also  "Loans") 
calculation,  74 

creation  of  deposits  by,  72,  73 
effect  of  time  on  credit  values,  42 
nature  of,  72 
Dollar, 

compensated,  172,  173 
silver,  19,  21 


Earning  assets,  relation  to  secondary 

reserve,  150 
Elasticity, 
aggregate  currency  having,  119 
contraction  and  expansion  in  Can- 
ada, 127,  128 
definition  of  bank  note,  116 
elastic  limit  in  Germany,  122 
methods  of  attaining, 

absence  of  restrictions,  118 
pledge    of     bonds     ineffectual, 

117 
pledge    of     commercial    paper, 

117 
provisions     for     contraction, 
118 


INDEX 


203 


England, 

bank  note  system,  120,  121 

bank  of,  120 
Equation  of  exchange,  162 
Exchange,  equation  of,  162 


Federal    reserve   bank    notes,    issue 

under  Pittman  Act,  22,  23 
Federal  reserve  notes,  form  of  govern- 
ment paper  or  credit  money,  59 
Fisher,  Irving, 

equation  of  exchange,  162 

plan  of  compensated  dollar,  172, 

173 

France,  bank  note  system,  120 
Free  coinage  (See  also  "Coinage") 

definition  of,  10 

limitation  of,  16 
Functions, 

bond  house,  187 

classification  by  bank,  180 

commercial  bank,  181 

commercial  banking,  84,  87,  88 

distinguished  from  operation,  87 

economic,    of    commercial    banks, 
182 

savings  bank,  186 

specialization  of  bank,  180 

trust  company,  192 


General  assets,   protection  of  bank 

notes  by,  113 
Germany, 

bank  note  system  of,  122,  123 

Reichsbank,  122,  123 
Gold, 

coins  in  circulation,  25 

ownership  of  in  United  States,  29 

shipments,  25 

stock  of,  29 


Gold  Standard  Act  of  1900,  22 

Greenbacks, 

characteristics  of,  56 
issues  and  contraction,  56 
reserve  against,  56 

Guaranty, 

deposit,  129  (See  also  "Deposits, 

guaranty  of") 
loaning  amounts  to,  75,  76 
protection  of  bank  notes  by,  116 


Inconvertible  paper,  51 
Index  numbers, 

base   prices    used  in    calculating, 
166 

commodities   used   in  calculating, 

165 

illustrations  of,  166,  167 

kind  of  average  used  in  calculating, 
166 

prices  used  in  calculating,  165 

war  inflation  evidenced  by,  168 
Inflation, 

advantages  of,  173 

causes  of,  106 

definition  of,  168 

dispersion  of,  169,  170 

effect  on  social  classes,  171 

indexes  bearing  on  war,  168 

inequalities  of,  169 

interest  rate  affected  by,  170 

physical  volume  of  trade  and,  168 
Interest, 

deposit  balances  earn,  70 

effect  of  inflation  on,  171 

relation  to  credit,  44 
Issuance,     method    of,    government 
paper,  59,  60 


Kansas, 
guaranty  of  deposits  in, 
banks  in  system,  137 


204 


INDEX 


Kansas — Continued 
guaranty  of  deposits  in — Continued 
Kansas  Bankers'  Deposit  Guar- 
anty and  Surety  Co.,  137 
strong  features  of,  136 
Kemmerer,  E.  W.,  inflation  indexes, 
168 


Lawful  money,  defined,  31 

Legal  tender,  8  (See  also  "Money") 

coins  of  United  States,  31,  32 

effect   on   value   of   inconvertible 
money,  52 

facilitation  of  bimetallism,  13 

limitation  of,  17 
Letter  of  credit,  protection  of,  155- 

157 
Lien  (See  "  Prior  lien") 
Limping  standard,  definition  of,  14 
Liquidity  of  assets  (See  also '  'Assets" ; 
"Convertibility";  "Reserve") 
assets  of  systems  having,  152-154 
earning  assets  feature,  151 
effect  of  war  on,  154 
function  of  central  bank   as    to, 

154 
Loans, 

distinguished  from  discounts,  74 

effect  on  bank  statement,  71,  72 

inter-bank,  158,  159 

nature  of,  71 

process  of  exchange  of  credits,  75, 

76 
ratio  to  deposits,  81 
vs.  acceptances,  157 


M 


Marginal  utility,  relation  to  price, 

161 
Market  ratio,  12 


Mint, 
functions  of  the,  33 
institutions  of  the,  32 
ratio, 

defined,  12 

history  of,  18 
relative  importance  of,  32 
statistics  of  coinage  of,  33 
Monetary  standard, 

bimetallism    and    monometallism, 

10-13 
Gold  Standard  Act  of  1900,  22 
limping,  14 
multiple, 

compensated    dollar    plan,  172, 
173 

definition  of,  171 

objections  to,  172 
Money  (See  also  "Coinage";  "Cur- 
rency"; "Gold";  "Greenbacks"; 

"Silver") 
banking  principles  and,  3 
barter  economy,  4 
circulation  of,  in  United  States,  62 
classification  of,  3 
commodities  used  as, 

characteristics,  6 

metals,  7 
functions, 

medium  of  exchange,  4,  5 

minor,  6 

standard  of  deferred  payments, 
5 

standard  of  value,  5 
legal  tender,  defined,  8 
metallic, 

coinage,  7-33 

location  of,  30 

ownership  of,  29 

stock  of,  29 

vs.  credit  money,  45 
paper, 

advantages  and  disadvantages, 
54 


INDEX 


205 


Money — Continued 
paper — Continued 
circulation  of,  62-65 
classification  of,  49-59 
convertible,  50 
credit  instruments,  48 
division  of  issue  and  redemption, 

59 
effects  of  overissue,  53 
federal  reserve  notes,  59 
gold  certificates,  58 
gold  order  certificates,  59 
greenbacks,  56 
inconvertible,  51 
issues,  55 
limitation  of,  52 
methods  of  maintaining  value, 

52 
methods  of  redemption,  60-62 
paper  or  credit  certificates,  49, 

58 
reasons  for  wide  acceptability  of, 

48 
silver  certificates,  49,  58 
treasury  notes  of  1890,  57 
United  States  issues  of,  55 
volume  of  redemption,  62 
quantity  theory  of,  162 
Monometallism,  definition  and  oper- 
ation, 10-13 
Multiple  standard    (See  "Monetary 
standard,  multiple") 

N 

Notes  (See  "Bank  notes") 
Note-brokers,   effect  on  commercial 

credit,  89 
Numbers  (See  "Index  numbers") 


Oklahoma, 
guaranty  of  deposits  in, 
assessments  made,  132 


Oklahoma — Continued 
guaranty  of  deposits  in — Continued 
funds  for,  132 
origin  of  law,  131 
payment  of  depositors,  133 
popularity  of  system,  135 
unfavorable  conditions  for,  133- 

135 
Operation,  distinguished  from  func- 
tion, 87 
Overproduction, 
causes  of,  174-177 

according  to  Carver,  177 
causes  of  panics,  174,  175 
definition  of,  174 


Panics, 
caused  by  overinvestment,  176 
caused     by     overproduction,  174, 

175 

financial  causes,  173,   174 
"money,"  174 
periodicity  of,  178 
psychological  factors,  178 

Paper  money  (See  "Money,  paper") 

Pittman  Act  of  1918,  22,  23 

Pledge, 
elasticity  of  bank  notes  achieved 

by,  117 
protection  of  bank  notes  by,  115 

Presentment,  time  of,  100 

Prices, 
definition  of,  161 
index  numbers  of,  165 
influences  on  prices  illustrated,  164 
multiple  standards  to  stabilize,  171 
relation  of  bank  credit  to,  162 
relation  to  utility,  161 
remote  influences  on,  163 
stabilization  of  level  of,  171 

Prior  lien,  protection  of  bank  notes 
by,  114 


206 


INDEX 


Protection       (See      "Acceptances"; 

"Bank  credit";  "Bank  notes"; 

"Bills    payable";     "Deposits"; 

"Letters  of  credit") 
Pujo    Committee,    investigation    of 

money  trust  by,  188 
Purchasing   power,    stabilization   of, 

171-173 


Quantity  theory  (See  "Money") 


Ratio  (See  also  "Market";  "Mint") 
cash  reserve  to  loans,  90-95 
investments    to    aggregate   assets, 

90-95 

loans  and  investments  to  aggregate 
assets,  90-95 

loans  to  aggregate  assets,  90-95 

loans  to  deposits,  81 
Redemption, 

convertible  paper,  50 

method  of,  of  government  paper, 
60-61 

protection  of  bank  notes  by  govern- 
ment, 115 

volume  of,  of  government  paper, 
62 
Reichsbank,  122,  123 
Reserve, 

desirability     of     legal     minimum, 
146,  147 

factors  determining  proper,  145 

importance  of  regulating,  150 

legal  minimum,   146 

maintenance  of  convertibility,  50 

methods  of  increasing, 
borrowing,  147,  148 
contraction  of  loans,  148 
liquidation  of  assets,  148 


Reserve — Continued 

methods  of  increasing — Continued 

synchronizing  receipts  and  loans, 
149 
minimum, 

against  bank  notes,  112 

against  deposits,  129 
protection  of  bank  credit,  145 
secondary, 

commercial  paper  as,  152 

convertibility  of,  151 

earning  power  of,  150 

forms  of,  151 

liquidity  of  system's,  152,   153 
Restriction,    bank    note    issue,  114, 

115 


Savings  banks, 

distribution  of,  185 

functions  of,  186 

guaranty  type  of,  185 

joint-stock,  184 

miscellaneous  types  of,  1 86 

mutual  or  trustee,  183 
Secondary  reserve  (See  "Reserve") 
Seigniorage, 

defined,  9 

effects  of,  10 

limitations  on,  15 

methods  of  taking,  15 

purposes  of,  9 

relation  of,  to  value  of  coins,  15 
Sherman  Silver  Act  of  1890,  21 
Shipments  (See  "Gold") 
Silver, 

certificates,  49 

coins  in  circulation,  26,  27 

dollar  coinage  history,  19-21,  22, 
23,  26 

ownership  of,  in  United  States,  29 

stock  of,  29 
Standard  (See "Monetary  standard") 
Statement  (See  "Bank  statement") 


INDEX 


207 


Subsidiary  coinage  (See  also  "Coin- 
age") 

Act  of  1853,  19 

characteristics  of,  1 7 

coins  in  circulation,  26 
Surplus, 

functions  of,  85,  86 

nature  of,  85,  86 


Tender  (See  "Legal  tender") 

Token,  coins  minted,  31 

Trade,  physical  volume  of,  and  in- 
flation, 168 

Treasury  notes  of  1890,  57,  58 

Trust  companies, 
advantages  over  individual  trustee, 

192 
bankruptcy  functions  of,  195 
corporate  financing  by,  196 


Trust  companies — Continued 
corporate  functions  of,  195 
fiscal  agents,  195 
general  functions  of,  192 
insurance  business  of,  196 
investment  functions  of,  194 
probate  functions  of,  193 
real  estate  functions  of,  194 
safe-deposit  business  of,  197 
transfer  agent  and  registrar,  196 
trust    functions    for    individuals, 
193-195 

U 

United  States  Treasury,  division  of 

issue  and  redemption,  59 
Undivided  profits,  nature  of,  85,  86 
Utility,  marginal,  relation  to  price, 
161 

W 

Wealth,  relation  of  credit  to,  43,  44 


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